ALMOST two years have passed since auditors delivered clean audit reports for the UK’s major banks, which were teetering on collapse.
They did this following private discussions with London’s city minister Lord Myners. During those discussions, which included the senior partners of the Big Four firms details, amounting to a virtual guarantee, that the Government would bail out collapsing banks.
Critics say auditors covered up the reality of the faltering banks finances. Auditors say their actions saved the economy from collapse.
The story begins with the collapse of Northern Rock, which for auditors and the markets at large, brought home the destructive power market speculators could have on UK banks.
Banking is built on confidence, confidence that in the event of a worst case scenario banks will be helped by government backed central banks.
Confidence was a quality in short supply in the days leading up to Northern Rock’s 2007 collapse.
Central bankers, seeing the excessive rewards being paid to bank executives, sought to caution the financial sector, insisting they should not take their position for granted.
In an attempt to shock the banks into curbing their riskier activities central banks sent a clear message: don’t count on us if you get into trouble.
However that slight erosion in confidence spread grew through the banking sector, and provided an opportunity for speculators to undermine the century’s old confidence upon which the banking sector sat.
The enormous sums which could be made from falling markets had provided ample incentive for hedge funds and other speculators to not just promote doubt about Northern Rock and other banks, but to actively undermine the bank in the days before its collapse through short selling. It was a phenomena which played out across the world.
But in the UK it was the collapse of Northern Rock which rewrote the rules.
Auditors, who had long relied upon the availability of liquidity and ultimately the central banks as a lender of last resort, , had to reassess some of their longest held assumptions. In a world heavy with speculation and mass media coverage, the ingredients were there for a run on banks, a situation which had not been seen for hundreds of years.
In the year following hope lifted briefly as markets began to stabilise from the Northern Rock Collapse, but it was short lived.
The sub prime market in the US began to rupture as banks slowly recognised their exposure to the toxic assets. However, it was the collapse of Lehman Brothers which sent shockwaves through the audit profession.
Auditors wondered whether they could avoid, modifying their audit reports for their banking clients, if the government could not guarantee support.
That the US government and its central bank had allowed a major bank to collapse, to implode, shook core assumptions in the audit profession. They began asking dangerous questions. If government support could not be guaranteed, how could auditors sign their audit reports, and, critically, their “going concern” reports.
Going concern guidance, is issued by auditors if they believe a company will survive the next year. In the volatile environment following the collapse of Lehman Brothers if auditors were to express doubt in a companies financial health they feared it would be tantamount to signing a death warrant for the bank, and lead to the complete collapse of the UK economy.
In that pressure-cooker environment the Big Four auditors needed evidence the banks would be able to survive the year and only the government could provide that support.
Only now do we know that the heads of the firms took the bold step of approaching government for a secret meeting – a claim which emerged during a House of Lords hearing last month. At that meeting, away from the public eye, the government provided detailed evidence of the support it would provide should the banks collapse. They told the auditors they would step in.
This provided the auditors with the evidence and confidence they needed to report on the basis that the entire UK banks would survive for at least the next year.
It’s also a move which has attracted controversy ever since it was aired at a dramatic exchange in the House of Lords committee investigating the role of audit last month.
“Are you saying that, looking at the position, you thought that the bank was likely to be in trouble but you couldn’t possibly say that because that might precipitate the crisis and, therefore, by giving assurance you took the view that the accounts were okay?” asked an astonished Lord Forsyth at the hearing last month.
Auditors, as ever, take a very clinical view of the situation.
Meetings with government served a purpose and that was to provide the evidence they needed to ensure there was liquidity support for the banks. In the event the wholesale markets dried up, auditors needed to know the government would step in, and it did.
“If we had started as a profession modifying the reports of banks, I think it is fair to say by the end of the week everyone would be going around with wheelbarrows with goods to barter,” one senior Big Four auditor said.
The House of Lord’s astonishment at the events add to a growing debate about the role of audit.
It shines a light on an almost overlooked moment in our recent history when, briefly, a handful of senior accountants held the future of the entire UK economy in their hands.
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