Fair value: what lies beneath?

Alex Hawkes, Accountancy Age

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

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

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

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