The role of fair-value accounting in the credit-market crisis

Some observers have suggested that fair-value accounting has exacerbated the credit-market crisis. Those who express this concern believe that fair values assigned to financial assets backed by certain mortgage loans have not reflected their underlying intrinsic or economic values. In turn, these commentators feel that the understated values have resulted in overstated losses and the need to raise additional capital. Arguably, the valuation and liquidity of other securities have been affected. In addition, it is possible that the confusion about the true values of various securities resulted in reduced levels of investor and creditor confidence. In an effort to provide a foundation to address some of these concerns, this paper provides detailed discussions on: the securitisation of subprime mortgages; the application of fair-value accounting to securities backed by subprime and ALT-A loans; and whether or not fair-value accounting for difficultto-value securities improves transparency, relevance, reliability, and comparability of financial reports.