Market reactions to policy deliberations on fair value accounting and impairment rules during the financial crisis of 2008–2009

Abstract

Fair value accounting (FVA) has been blamed for amplifying the financial crisis of 2008–2009. We investigate investor and creditor reactions to policymaker deliberations, recommendations and decisions about FVA and impairment rules in the banking industry. If FVA was a key contributor to the financial crisis as some industry pundits and academic research suggest, we first should observe positive stock market reactions to proposals that relax FVA rules and negative reactions when policymakers support FVA. Second, we investigate cross-sectional stock price reactions to bank-specific factors that potentially contributed to pro-cyclical contagion. Third, we examine whether banks that have fewer alternative sources of information about fair values experience relatively negative reactions to potential relaxation of FVA and impairment rules. Finally, we investigate credit market reactions to these policy deliberations, recommendations and decisions by examining changes in credit default swap spreads for a subset of banks in our sample.Our first result suggests that investors acted as if the potential negative effects of then-existing FVA and impairment rules outweighed any benefits associated with having more timely and transparent mark-to-market data for decision-making. Second, while our cross-sectional test results are mixed, our most robust result suggests that the magnitude of stock price reactions to the relaxation of FVA and impairment rules was positively related to the proportion of banks’ illiquid assets. Third, we provide mixed evidence that banks without analyst coverage (and thus presumably fewer alternative sources about fair values) were harmed by proposals and policies that relaxed FVA and impairment rules. Finally, our results on credit market reactions suggest that positive stock market reactions to the potential relaxation of FVA rules are not likely caused by wealth transfers from creditors to shareholders.