Fair value: what lies beneath?

Financial News, the investment banking publication, says banks have declared a total of $140bn (£70.8bn) in writedowns. The IMF is worried there will be a total of $1trillion in losses once the credit crunch is over.

The finger is pointed at fair value accounting. The method has, according to its critics, led to the use of market values in accounts that bear no relation to reality. The writedown in bank balance sheets are, it is claimed, leading people to lack confidence in those banks, causing runs on the bank and other issues.

Actually, I think this analysis rather puts the cart before the horse. The credit crunch was in full swing before most of these writedowns were announced. It isn’t the writedowns that are worrying people, but the threat of the writedowns.

The banks are worried about lending to each other because they don’t know how big the problems are with rivals, and don’t want to risk large amounts of capital. Why don’t they know?

Not because the accounting is leading to excessive volatility. It is because they don’t know whether X’s sub-prime derivatives are worse than Y’s. The accounts don’t tell them that.

The chain of risk assessment in the passing on of the sub-prime assets is the thing they want to know about. No accounting method is going to tell them that ­ not even fair value. The blogger Chris Dillow points out that there may be $1trillion of losses on sub-prime. But there have been $5.6 trillion of losses on equity markets Worldwide
since October.

Surely it isn’t the scale of these losses, or the volatility, but uncertainty about where the losses really, rather than apparently, lie?

Alex Hawkes is the News Editor of Accountancy Age