Mark-to-Market Accounting: Guilty or Not?

Abstract

As the recent credit crisis unfolded, fair value accounting provoked a fierce debate among politics, academics, and bankers. Even though many believe that fair value accounting exacerbated the crisis, some commentators argue that fair value accounting was the prime reason for the financial meltdown. Proponents, on the other hand, believe fair value accounting prevented more calamitous consequences of the credit crisis by acting as an early warning system. This article traces the role of fair value accounting during the crisis in light of these arguments. In this context, the article focuses on two key arguments so as to find out whether fair value worsened the crisis. The first argument is that fair value accounting played a significant role in actual or potential bank failures. With respect to bank failures, we found that fair value accounting did not play a significant role during the crisis. The problem for many broker-dealers and banks was short-term funding difficulty after the interbank markets dried up. For some others, credit losses rather than fair value losses played a key role in bank failures. The second argument in the context of the crisis was the alleged procyclical effects of fair value accounting. Given its hybrid features and the extent to which it impacted upon balance sheets as revealed by empirical data, we conclude that fair value accounting in its current form did not cause pro-cyclical behavior and a downward spiral.

TOPICS: Accounting and ratio analysis, legal and regulatory issues for structured finance