Question

Through reading the case of Subprime crisis and Fair-value Accounting by Paul M. Healy, Krishna G. Palepu and George Serafeim, what are the arguments of those supporting fair value accounting ? Associated with the data to answer this question

Answer 1

In IAS 39 Fair Value Accounting (FVA) is defined as the price at which an asset could be exchanged between willing parties. FAS 157 defines FVA as the price that would received to sell of an asset or paid to the transfer a liability between the market participants.

With reference to " CASE STUDY" The root of this crisis is bad mortgage loans, but today we face 70% of the real crisis is caused by market to market accounting in an illiquid market.

It was arguing that FVA played a sustantial role in financial crisis. For the latest credit crisis FVA has been blamed. Because of inactivity of the markets, FVA contributes to excessive impossible to perform a reliable market valuation.

One argument is that majority of the corporate bonds, mortgage and structured debt were still performing. But as the market is frozen, the prices of these assets had fallen below their true value.

Most Assets of Financial Institutions are marked to market - According to SEC study in late 2008, only 31% of bank assets were treated in this trend and the rest was accounted at historical cost. Wesbury and forbes argue that many banks towards insolvency are pushed by marking to market and forced them to unload assets at fire sale prices, which then caused further fall in values. In such arguments, politicians in the United States and Europe has called for suspension of Fair value accounting in favor of historical cost accounting, where assets are valued at original price.