Professional Documents
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Financial crisis
Origins: performance of subprime mortgages in the US Results:
Liquidity virtually disappeared from important markets Stock markets plunged Triggered a wave of bailouts Many economies slipped into recession September 2007, total write-offs $760 billion October 2008, total loss prediction by IMF $1.4 trillion
Why did the subprime-mortgage crisis bring down the whole financial system and economy? What explains the difference? Fair value accounting?
Financial Instruments (II)
-166 950
Income statement Interest income Interest expense Revaluation of financial assets Net income 60 95 216 -241
Financial Instruments (II)
But: The opponents suggest that timeliness worked differently during current financial crisis
This boom was not supported by the earnings, cash flow and dividend fundamentals for the UK. The market rose 300% and the fundamentals 100%
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1,5
CASH FLOW
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0 1 22 43 64 85 106 127 148 169 190 211 232 253 274 295 316 337 358 379 400 421 442 463 484 505 526 547 568 589 610 631 652 673 694 715
UK 1965-1970
65-70 UK
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This is not new. Many other instances are obvious in the last 40 years for example the late sixties in the UK.
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What is this?
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0 1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 121 129 137 145 153 161 169 177 185 193 201 209 217 225 233 241 249 257 265 273 281
Excess volatility
Fair values accounting forces to quickly acknowledge adverse developments and to take corrective actions without undue delay (Hellwig 2008) Necessary to exert market discipline to correct Appropriate if the bank wants to hold to maturity? Write-offs will force a bank to take corrective actions As write-offs decrease equity, corrective actions are likely to involve some deleveraging, i.e. some sale of assets to reduce leverage If the assets in question are the very assets for which markets are not functioning, the book losses turn into real losses These losses would have not been there under historical cost model Corrective actions themselves will feed back into the financial system Selling leads to further selling etc etc etc
Neutral
Previous slides implicitly assume that measurement issues (e.g., reliance on fair value accounting) affect economic behaviour Is it so? Scant empirical evidence: only several studies were able to document an effect (Beatty 2007) Little evidence: Not interesting? Or no results to publish? Fair value accounting merely reflects real problems (Veron 2008) The markets react positive to write-downs (UBS: write-down - $19 bil.; share price increased by 15%) Blaming it on fair value accounting is akin to killing the messenger
Financial Instruments (II)
Percentage of assets for which changes in fair value affected income was significantly less (25%) Fair value measurements did significantly affect financial institutions reported income
Financial Instruments (II)
But.....
Fair value and mark-to-market accounting do not appear to be the cause of bank and other financial institution failures Rather than a crisis precipitated by fair value accounting, the crisis was a run on the bank Interesting they looked at impairments as a cause of the bubble bursting....not the initial write ups! Recommendation: General-purpose financial reporting should not be revised to meet the needs of other parties if doing so would compromise the needs of investors