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Fair Value Accounting is the Wrong Scapegoat for this Crisis

Fair Value Accounting is the Wrong Scapegoat for this Crisis

Abstract

The ongoing financial crisis has spurred much finger-pointing at fair value accounting for financial instruments, as set out in both leading sets of accounting standards used by listed companies around the world, namely the US Generally Accepted Accounting Principles (US GAAP) and the International Financial Reporting Standards (IFRS). Prominent financial leaders such as Martin Sullivan, former CEO of AIG, and Henri de Castries, CEO of AXA, have singled out fair value and the related wide use of mark-to-market accounting as a major factor in the crisis (see Hughes and Tett, 2008 ). Echoing these views, European Commissioner Charlie McCreevy expressed his concern on 1 April this year about the 'impact of mark to market valuation when markets generally become illiquid and irrational' (McCreevy, 2008 ). On closer inspection, there is not just one criticism of fair value accounting, but two, centring respectively on illiquidity and procyclicality. The illiquidity criticism focuses on complex products resulting from securitisation of assets such as mortgage loans, which are at the core of the current financial crisis. Both IFRS and US GAAP define the fair value of financial instruments under a three-level framework: it is set as the observable market price of the
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