Essay about Fair-Value Accounting and the Financial Crisis

Essay about Fair-Value Accounting and the Financial Crisis

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Market crashes are nearly as old as the invention of money itself. But, as Gillian Tett underlines in Fool’s Gold, “the latest financial crisis stands out due to its sheer size”. Economists estimate total losses could sum up to $2000 to $4000 billion, a number surprisingly not dissimilar to the British Gross Domestic Product. In its post-mortem, the self-inflicted disaster has commonly brought to light the question: “Did bankers, regulators and rating agencies fail to see the flaws, or did they fail to care?” Importantly, it has also created a hunt for scapegoats and quick fixes.
Many Republicans and industry lobbyists have insisted that the financial meltdown would not have been nearly as bad if not for the deadly Fair-Value Accounting (FVA) standard. It is, however, my stand that accounting is not the root cause of the financial crisis. I argue that the mixed-attribute model prompted considerable accounting-motivated structures. And due to the selective application of FVA, it did not in practice; contribute to the pro-cyclicality of the financial system. Nor would the meltdown have otherwise been avoided under a different accounting scheme. I note that the crisis has had standard-setting implications, and the prompt reshaping of current standards plays an important role in its resolution.
To begin, a recurring allegation amongst critics of FVA is that it contributed to the pro-cyclicality of the financial system. This criticism contended that, during the bust, FVA write-downs led to an overblown write-down of the value of financial assets and an overstatement of losses. This led to the contagion effect and downward spiral of capital destruction as outlined in Figure 1. And hence is pinpointed as a root cause of the financial...

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... to the Financial Crisis?” Christian Laux and Christian Leuz, Journal of Economic Perspectives 2010
• “The crisis of fair-value accounting: Making sense of the recent debate” Christian Laux and Christian Leuz, Accounting Organizations and Society 2009
• “Is It Fair to Blame Fair Value Accounting for the Financial Crisis?” Robert C. Pozen, The Harvard Business Review 2009
• “Blaming the Bean-Counters” The Washington Post 2009
• “Fair Value Accounting: Understanding the issues raised by the credit crunch” Stephen G. Ryan, 2008
• “Accounting Did Not Cause the Crisis” The Global Association of Investment Professionals, CFA Institute 2009
• “Accounting Practices: Did Fair-Value Cause the Crisis?” Australian School of Business 2011
• “Report of the Financial Crisis Advisory Group” 2009
• “US senate committee tackles financial crisis prevention” The Accountant 2011

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