In response, and echoing Roosevelt in 1938, President Bush granted the SEC authority to suspend fair value rules. Although this authority was not invoked, it demonstrated a willingness to provide system-wide forbearance through fair value accounting rules. Today, the self-same cycle is in motion. During the long pre-crisis boom, fair value principles gained ground, in particular in the valuation of debt, equity and derivatives: in the US, through Statement of Financial Accounting Standard 157 (SFAS 157); internationally, through International Accounting Standard 39 (IAS 39). As in the roaring ‘20s, rising asset prices, marked to market, inflated bank profits and balance sheets. Between 2000 and 2007, major international banks recorded accumulated gains in their trading book totalling over £ billion. But as the crisis tide has turned, with falling asset prices and failing banks, so too has the fair value debate. In 2008, under intense pressure from an ailing banking community, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) eased back on fair value accounting rules. For example, banks were allowed to switch financial instruments from trading to holding to avoid mark-to market requirements. So, historically, fair value accounting principles have gained ground when the going has been good, and lost it when it has got tough. From a financial stability perspective, this is a cause for concern. To see why, consider how banks’ balance sheets then appear to investors. During the asset upswing, fair value gains ground. Mark-to-market gains are booked as profits.
It has a history stretching back at least a century. The fortunes of this debate have been shaped importantly by financial crises. Indeed, a clear historical pattern has emerged: fair value accounting principles have waxed when asset prices and banks are rising and waned when both are falling.2 Consider experience in the United States either side of the Great Depression. Fair value principles were rolled-out progressively during the early part of the 20th century. This move was led by the banks who held marketable securities as assets. As these securities rose in value ahead of the Great Crash, marking them to market allowed profits to be booked. Rising asset prices and bank profits went hand in hand, with fair values playing the role of matchmaker. That was one reason why the “roaring ‘20s” roared. The stock market crash of 1929 put paid to this happy marriage. Falling asset prices, marked to market, crushed bank profits and balance sheets. In the United States, around 10,000 banks went bust between 1929 and 1938. Fair values were now seen as more troublemaker than matchmaker. Pressures to suspend fair values, from banks, regulators and politicians, began to mount. By 1938, after an initial recovery from the Great Crash, the United States was bracing itself for a double-dip recession. In response, under pressure from the Federal Reserve, President Roosevelt suspended fair valuation of investment bank assets.