The Global Financial crisis was one of the largest that happened in the year 2008-09. The accounting techniques of fair value accounting has been blamed for the longest of time. The techniques of fair value accounting were blamed and questioned (Lane & Milesi-Ferretti, 2018). Problematic techniques of fair value accounting are described in the following paragraph.
Techniques of fair value accounting were criticized based on not being able to give a view that is transparent for the crisis that has happened globally. According to the fair value measure, it is required that the liabilities and assets are depicted at the value in the balance sheet that is prevailing in the market. The basic problem that occurred was that during the time of boom, fair value helps in providing extra leverage while at the time of depression extra write-downs are done. This is where the problem was created during the Global financial crisis. Once the downfall in the economy started because of the busting of the housing and sub-prime bubble, the debt utilization by the public stopped and the investments and the spendings that were being made were reduced. Losses were made by the banks and prices started tripping down (Zhang et al., 2020). Also, debts were not being paid. This started a cycle of a downward trend in the economy. Due to this, there were various mortgages, bonds, and debts that were performing appropriately yet the fall in the prices of banks led to a reduction in their value too. This forced the banks for selling their assets at the value that is prevailing in the market. So, as per the technique of fair value even if the prices fall for a short period, banks have to decline their cost which in turn increases the chances of insolvency. Because of this technique of fair value Global financial crisis in the year 2008-09 happened.
In my opinion, the fair value technique was not the reason that created the crisis globally. A survey report that was conducted by SEC stated that only around 31% of banks used the Fair value accounting technique. Also, in the technique, there are 3 levels. At level 1, assets are defined at market price. At level 2, inputs are taken into consideration when the prices of the market are not available and at Level 3, executives define the prizes when the markets go illiquid. At the time of the financial crisis, markets froze and become illiquid. Executives were deciding the prices. The main problem in the financial crisis was that the loans were provided recklessly and collateral securities were not huge. There is no evidence that states that if assets were marked at the historical cost, the problem would not have occurred. The fair value thus was not the reason for the faults that were done by taking huge risks.
After the crisis, various changes were made in the standard of the Fair Value Technique. Various modifications were made in the technique of fair value accounting. Disclosure requirements for the non-public entities were removed. It also included the changes in gains and losses that were unrealized. The process that used to be undertaken for valuation at level 3 for the non-public entities was removed. But the quantitative information was to be provided even of the unobservable inputs.
Another change that was brought in was the addition of additional disclosure for the calculation of level 3 fair value techniques. Through this weighted average of assets for the entity is to be calculated and is to be shown accordingly (DeFond et. al., 2019). Also, the changes that have occurred in the unrealized gains are to be depicted at the end of the year or the pending period. 'At a minimum' phrase was deleted so that appropriate consideration value can be defined. Another point that was added was that the measurement of uncertainty should be communicated on the date of reporting rather than waiting for the sensitivity changes at future value. This will help in depicting a better position of assets as public entities will be required to depict the unobservable value and also changes that are being circulated will be reported on the same date as they have been found out rather than on any future based value. So, better reporting will be done after the changes and fair value will be presented appropriately.
Fair value accounting played a little role in the global financial crisis. The main reason was the risks that were taken by the banks without collateral. This created the damage and after the bursting of the housing bubble, a downward trend started. Yet certain changes like the removal of the word voluntary disclosure with the minimum and better disclosure requirement can help in providing a better view and transparency in the Fair value accounting technique.
DeFond, M. L., Hu, J., Hung, M., & Li, S. (2019). The effect of fair value accounting on the performance evaluation role of earnings. Available at SSRN 3466021. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3466021
Lane, P. R., & Milesi-Ferretti, G. M. (2018). The external wealth of nations revisited: international financial integration in the aftermath of the global financial crisis. IMF Economic Review, 66(1), 189-222.
Zhang, L., Farooq, Q., Zhang, Y., Liu, X., & Hao, Y. (2020). Fair value and mispricing: how domestic earnings transparency of listed firms leads to global financial stability. European Journal of International Management, 14(1), 173-193.
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