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...
... middle of paper ...
... 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
The financial crisis of 2007–2008 is considered by many economists the worst financial crisis since the Great Depression of the 1930s. This crisis resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. The crisis led to a series of events including: the 2008–2012 global recessions and the European sovereign-debt crisis. The reasons of this financial crisis are argued by economists. The performance of the Federal Reserve becomes a focal point in this argument.
Market crashes are not a new phenomenon but the most disturbing fact about the financial crisis of 2008, was that it was self-inflicted. What started as a credit crunch during the early 2006, turned into a fully-blown recession by mid-2008.The world’s financial system received a huge shock in September 2008, with the collapse of The Lehman Brothers, one of the biggest global investment banks [3]. The Global Financial Crisis of 2008, was undoubtedly the worst economic slump since the Great Depression of 1930. While the bankers and financers hold the responsibility for the global economic turmoil, the business schools have also, being partially responsible, faced criticism.
Wolk, H., Dodd, J., & Tearney, M. (2003). Accounting Theory: Conceptual Issues in a Political and Economic Environment (6th edition ed.). South-Western College Pub.
Cabral, R. (2013). A perspective on the symptoms and causes of the financial crisis. Journal of Banking & Finance, 37, 103-117
Hines, R. D. (1991). The FASB’s conceptual framework, financial accounting and the maintenance of the social world. Accounting organizations and society, 16(4), 313-331.
The "subprime crises" was one of the most significant financial events since the Great Depression and definitely left a mark upon the country as we remain upon a steady path towards recovering fully. The financial crisis of 2008, became a defining moment within the infrastructure of the US financial system and its need for restructuring. One of the main moments that alerted the global economy of our declining state was the bankruptcy of Lehman Brothers on Sunday, September 14, 2008 and after this the economy began spreading as companies and individuals were struggling to find a way around this crisis. (Murphy, 2008) The US banking sector was first hit with a crisis amongst liquidity and declining world stock markets as well. The subprime mortgage crisis was characterized by a decrease within the housing market due to excessive individuals and corporate debt along with risky lending and borrowing practices. Over time, the market apparently began displaying more weaknesses as the global financial system was being affected. With this being said, this brings into question about who is actually to assume blame for this financial fiasco. It is extremely hard to just assign blame to one individual party as there were many different factors at work here. This paper will analyze how the stakeholders created a financial disaster and did nothing to prevent it as the credit rating agencies created an amount of turmoil due to their unethical decisions and costly mistakes.
Fair value is the market value at which an asset can be sold or bought. Ryan (2008) highlights many criticisms regarding fair value accounting, these include the reported losses being misleading because when markets return to normal the losses will reverse. When a company revaluates assets or liabilities at a time when the market condition is bad, the value of the assets and liabilities begin to 'swing '. However, once the market stabilises, assets and liabilities will be revalued at their original levels. This makes reports of gains and losses temporary which can be misleading to potential investors (Penman, 2007). Fair values being unreliable as they are difficult to estimate especially if the market is illiquid. And reported losses producing further losses which increases the overall risk of the financial system. For example, if the current market price for an asset drops and thus revaluing the asset downward, people might begin buying this asset at even more lower prices (Benston,
Throughout the past several years major corporate scandals have rocked the economy and hurt investor confidence. The largest bankruptcies in history have resulted from greedy executives that “cook the books” to gain the numbers they want. These scandals typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of assets or underreporting of liabilities, sometimes with the cooperation of officials in other corporations (Medura 1-3). In response to the increasing number of scandals the US government amended the Sarbanes Oxley act of 2002 to mitigate these problems. Sarbanes Oxley has extensive regulations that hold the CEO and top executives responsible for the numbers they report but problems still occur. To ensure proper accounting standards have been used Sarbanes Oxley also requires that public companies be audited by accounting firms (Livingstone). The problem is that the accounting firms are also public companies that also have to look after their bottom line while still remaining objective with the corporations they audit. When an accounting firm is hired the company that hired them has the power in the relationship. When the company has the power they can bully the firm into doing what they tell them to do. The accounting firm then loses its objectivity and independence making their job ineffective and not accomplishing their goal of honest accounting (Gerard). Their have been 379 convictions of fraud to date, and 3 to 6 new cases opening per month. The problem has clearly not been solved (Ulinski).
Within the next few years, the most important accounting issue that needs to be resolved is in regards to the use of fair value accounting. There is a great divide between historic and fair value accounting and there are many pro’s and con’s to each side, but to which method would be the best to fairly state the actual and true cost of something. The current issue with fair value is the valuation process of some items; most notably one would point out level three assets/liabilities. Levels one and two can be easily determined by looking to the market for guidance and there are identical and observable assets/liabilities to compare these to. Therefore, those items are valued immediately and correctly. But when you get to a level three asset/liability, it is up to the preparers “best judgment” to put a value on that item. This valuation cannot be found using observable similar inputs on the market since they can be unique and hard to compare to other assets/liabilities such as a building. At this point, the judgment of the preparer can be either over or under, and this amount could be ...
The global financial crisis has brought significant focus on the accounting model for financial instruments, both in the United States and around the world. The significant rise in the volumes of asset securitizations and derivative financial instrument transactions has served to bring attention to particular features of accounting standards. The harshest criticisms often relate to the substantial use of fair value accounting for many financial instruments.
The move towards fair-value accounting should be continued for many reasons. When comparing fair value, or market value, to historical cost, fair value gives a more relevant and updated view of what a particular asset or liability is truly worth. This promotes transparency of a company’s operations and gives stakeholders and potential investors an accurate look at the company’s worth. If assets and liabilities are sitting on the company’s books at historical value, this information can quickly become out-of-date. Fair value method of accounting also limits a company’s ability to lie about their income and make it look better than it actually is by using gains or losses from sales to increase or decrease net income. Since gains or losses
Fair value accounting is the acceptable amount relating to a particular asset that is equitable and unbiased (Drury & Colin, 124). Under fair value measurements, it is necessary to keep measuring the assets often so as to reflect the fluctuations happening in the market; explaining its volatile nature in a given financial period. Various factors should be considered when determining the fair value, and they include the production costs, distribution costs, the risk characteristics and the cost of related products in the market (Drury & Colin, 126).
In the case of Level 3 fair value estimates, managers have private information concerning appropriate values underlying economic value of items in the financial statements. This organization’s information creates two different problems, moral risk and adverse selection. Also in the more realistic setting, neither the balance sheet and income statement reflects fully all fair value relevant information although management discretion can reduce from its relevance. The risks of fair value accounting disclose no basis for recognizing income but realized gains and losses. While the concept of core earnings may provide value relevant information to financial statement users, the concepts of earnings and fair values have no correlation (Barth & Landsman,
On the other hand, fair value accounting raises the concerns of reliability. The estimation of fair value tends to be subjective since because “many assets and liabilities do not have an active markets, therefore the valuations are less reliable” (Bies, 2005). It is reliable only if markets for assets and liabilities are liquid and transparent. Even though fair value accounting has its own importance in term of measurement, the perspective of historical cost should be taken into account. As fair value reflects the current market conditions, an asset for example should have been valued at $50,000 may suddenly fall to $30,000 due to the economic downturn. It results a loss of $20,000 in net income since historical perspective was ignored. Also,
DR Scott, who was one of the pioneers in promoting the need for a conceptual framework in the field of accounting, said in one of his studies during 1931, “If we are going to be able to look ahead with assurance, we must be able to look back with accuracy”. Following this saying, the essay aims to critically evaluate DR Scott’s claim that “Disputes about the appropriateness of accounting techniques should not be resolved by appeal to practice or tradition”. For our case, I will shed light on the field of accounting and why is it imperat...