RR-370-CCEG Fair Value Accounting, Historical Cost Accounting, and Systemic Risk

Fair value accounting (FVA) refers to the practice of updating the valuation of assets or securities on a regular basis, ideally by reference to current prices for similar assets or securities established in the context of a liquid market; historical cost accounting (HCA) instead records the value of an asset as the price at which it was originally purchased. In the wake of the 2008 financial crisis, conflicting arguments have been made about the contributions of valuation approaches in triggering the crisis. This report investigates and clarifies the relationship between these two accounting approaches and risks to the financial system. The authors examine the risk implications of FVA and HCA in the various situations in which each is used; assess the role that these accounting approaches have played historically in financial crises, including the 2008 financial crisis, the savings and loan crisis of the 1980s, and the less developed country debt crisis of the 1970s; and explore insights about systemic risk that can be gleaned from better understanding the accounting approaches. The authors find that FVA was probably not a primary driver of the 2008 crisis. Moreover, they suggest