Fair Value Accounting, Financial Stability and the Global Financial Crisis

Abstract

When analysing the GFC and other crisis, it is important to identify the root cause(s), trigger(s) and amplifier(s). Crisis experience suggests that there is almost always a build-up period facilitated by one or more root causes. A set of root causes and amplifiers are needed for a market disruption as severe as GFC to come to existence. Without these, market disruption caused by trigger event is highly likely to be contained. GFC was a multifaceted disruption; it had various components which contributed to the build-up of the crisis and the resulting contagion. It was a reflection of structural flaws in the financial system, mainly in US. Often-quoted issues like excessive use of leverage, securitization, derivative markets and credit ratings are mostly a result of these structural flaws in the financial system. Problems relating to lack or lag of regulation and inadequate supervision also had a substantial role. FVA may have acted as an amplifier during the GFC. However, if any, its impact was limited. FVA has some serious flaws, like hypothetical market participant and her hypothetical assumptions, but it should be kept in mind that FVA standards are more of a strong guidance, not a straightforward recipe.