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Is mark-to-market accounting destabilizing? Analysis and implications for policy

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  • Heaton, John C.
  • Lucas, Deborah
  • McDonald, Robert L.

Abstract

Fundamental economic principles provide a rationale for requiring financial institutions to use mark-to-market, or fair value, accounting for financial reporting. The recent turmoil in financial markets, however, has raised questions about whether fair value accounting is exacerbating the problems. In this paper, we review the history and practice of fair value accounting, and summarize the literature on the channels through which it can adversely affect the real economy. We propose a new model to study the interaction of accounting rules with regulatory capital requirements, and show that even when market prices always reflect fundamental values, the interaction of fair value accounting rules and a simple capital requirement can create inefficiencies that are absent when capital is measured by adjusted book value. These distortions can be avoided, however, by redefining capital requirements to be procyclical rather than by abandoning fair value accounting and the other benefits that it provides.

Suggested Citation

  • Heaton, John C. & Lucas, Deborah & McDonald, Robert L., 2010. "Is mark-to-market accounting destabilizing? Analysis and implications for policy," Journal of Monetary Economics, Elsevier, vol. 57(1), pages 64-75, January.
  • Handle: RePEc:eee:moneco:v:57:y:2010:i:1:p:64-75
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    References listed on IDEAS

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    1. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    2. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1215-1256.
    3. Guillaume Plantin & Haresh Sapra & Hyun Song Shin, 2008. "Marking-to-Market: Panacea or Pandora's Box?," Journal of Accounting Research, Wiley Blackwell, vol. 46(2), pages 435-460, May.
    4. Allen, Franklin & Carletti, Elena, 2008. "Mark-to-market accounting and liquidity pricing," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 358-378, August.
    5. Xiong, Wei, 2001. "Convergence trading with wealth effects: an amplification mechanism in financial markets," Journal of Financial Economics, Elsevier, vol. 62(2), pages 247-292, November.
    6. Wayne Landsman, 2006. "Fair value accounting for financial instruments: some implications for bank regulation," BIS Working Papers 209, Bank for International Settlements.
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    Citations

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    Cited by:

    1. Maurer, Raimond & Mitchell, Olivia S. & Rogalla, Ralph & Siegelin, Ivonne, 2016. "Accounting and actuarial smoothing of retirement payouts in participating life annuities," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 268-283.
    2. Luc Laeven & Harry Huizinga, 2009. "Accounting discretion of banks during a financial crisis," IMF Working Papers 09/207, International Monetary Fund.
    3. Robert McDonald & Anna Paulson, 2015. "AIG in Hindsight," Journal of Economic Perspectives, American Economic Association, vol. 29(2), pages 81-106, Spring.
    4. Leila Gharbi & Khamoussi Halioui, 2011. "La juste valeur des instruments financiers : Un nouveau canal de contagion ?," Post-Print hal-00650435, HAL.
    5. Justin Chircop & Zoltán Novotny-Farkas, 2014. "The economic consequences of including fair value adjustments to shareholders’ equity in regulatory capital calculations," IEHAS Discussion Papers 1426, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
    6. Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2014. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," CSEF Working Papers 375, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    7. Huang, Xin & Zhou, Hao & Zhu, Haibin, 2012. "Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis," Journal of Financial Stability, Elsevier, vol. 8(3), pages 193-205.
    8. Mary E. Barth & Javier Gomez-Biscarri & Ron Kasznik & Germán López-Espinosa, 2012. "Fair Value Accounting, Earnings Management and the use of Available-for-Sale Instruments by Bank Managers," Faculty Working Papers 05/12, School of Economics and Business Administration, University of Navarra.
    9. Philip Bond & Yaron Leitner, 2010. "Market run-ups, market freezes, and leverage," Working Papers 10-36, Federal Reserve Bank of Philadelphia.
    10. John H. Cochrane, 2011. "Discount Rates," NBER Working Papers 16972, National Bureau of Economic Research, Inc.
    11. Ellul, Andrew & Jotikasthira, Chotibhak & Lundblad, Christian T. & Wang, Yihui, 2013. "Mark-to-market accounting and systemic risk: evidence from the insurance industry," LSE Research Online Documents on Economics 60968, London School of Economics and Political Science, LSE Library.
    12. Philip Bond & Yaron Leitner, 2009. "Why do markets freeze?," Working Papers 09-24, Federal Reserve Bank of Philadelphia.
    13. Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2012. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," FMG Discussion Papers dp701, Financial Markets Group.
    14. Ellul, Andrew & Jotikasthira, Chotibhak & Lundblad, Christian T & Wang, Yihui, 2015. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," CEPR Discussion Papers 10450, C.E.P.R. Discussion Papers.
    15. Ray Ball & Xi Li & Lakshmanan Shivakumar, 2015. "Contractibility and Transparency of Financial Statement Information Prepared Under IFRS: Evidence from Debt Contracts Around IFRS Adoption," Journal of Accounting Research, Wiley Blackwell, vol. 53(5), pages 915-963, December.
    16. Allen, Franklin & Carletti, Elena, 2013. "New theories to underpin financial reform," Journal of Financial Stability, Elsevier, vol. 9(2), pages 242-249.
    17. Bond, Philip & Leitner, Yaron, 2015. "Market run-ups, market freezes, inventories, and leverage," Journal of Financial Economics, Elsevier, vol. 115(1), pages 155-167.
    18. Gaëtan Le Quang, 2018. ""Taking Diversity into Account": Real Effects of Accounting Measurement on Asset Allocation," EconomiX Working Papers 2018-28, University of Paris Nanterre, EconomiX.
    19. repec:eee:jfinec:v:126:y:2017:i:1:p:1-35 is not listed on IDEAS

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