1/11/2024 0 Comments Marked to market![]() Management ran the business as if the unrealized gains arising via fair value accounting were realized in the form of cash. Fair value accounting is not grounded in cash. Fair value accounting changes the recognition and measurement criteria that financial statement users are accustomed. Most of the people in the financial community studied the traditional accounting model-the accrual basis model that is grounded in cash. As such only a handful of those in the financial arena have a firm grasp on fair value accounting. Fair value accounting has only been on the scene since 2006. However, it appears that the contribution of fair value accounting to the mortgage crisis was more the result of the fact that accountants, auditors, and investors were uneducated or undereducated with regard to fair value accounting. Fair value accounting may have exacerbated the problem but, it was argued, served only as a scoreboard. These factors included financial illiteracy, excessive leverage, rampant speculation, relaxed lending standards, mortgage innovations, failed regulation, unqualified borrowers, contagion in the market, and greedy investment bankers/institutional investors. Then there were others that argued that the financial meltdown was caused by a host of factors totally unrelated to fair value accounting. People also questioned exactly what was to be depicted by fair value accounting-the market value of the entity or the success or failure of management in operating the business. ![]() There were those that argued that the measurement system used in fair value accounting was not related to cash flow, worked well in an orderly market but not in a market requiring forced liquidation, did not clearly spell out that financial instruments should have been valued at Level 3 inputs instead of Level 1 inputs in a seized market, and created an arena where accountants were not fully equipped to participate. Even though mark-to-market accounting does not cause financial crises, it does magnify fundamental procyclicality which is inherent in efficient markets.ĭuring the recent financial crisis fair value accounting received its share of the blame for the meltdown. We consider the long term relationship between US GDP and the S&P 500 index values and key historical developments to conclude that implementation of mark-to-market accounting contributes to creating of asset bubbles and assets overestimations. Primarily, we will point out the historical context of the implementation of mark-to-market accounting and consequences it has, since it seems that some lessons from the past have been forgotten. Most studies that had similar conclusions dealt with the 2006-2008 period, whereas we focus our research on period from 1881 to present day. Even though the results of numerous studies on this topic offer various conclusions, the majority of them conclude that fair value accounting, or mark-to-market accounting, does not cause financial crises. The main objective of this paper is to provide an analysis on whether mark-to-market accounting magnifies financial crises.
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