Accounting in and for the Subprime Crisis

Abstract:     
This essay describes implications of the subprime crisis for accounting. First, I overview the institutional and market aspects of subprime mortgages and other positions, focusing on those with the greatest relevance for accounting. I explain how the investment performance of subprime-mortgage-related positions has a binary quality that depends on subprime mortgagors' ability to obtain cash-out refinancing. I describe how the subprime crisis evolved in four waves that roped in more positions and affected those positions more severely over time. Second, I discuss the critical aspects of FAS 157's definition of fair value and guidance for fair value measurements. I explain the practical difficulties that have arisen in applying that definition and guidance to subprime positions in the current illiquid markets. I also raise a potential issue regarding the application of FAS 159's fair value option. Third, I discuss issues that have arisen regarding sale accounting for subprime mortgage securitizations under FAS 140 and consolidation of securitization entities under FIN 46(R) associated with foreclosures and modifications of mortgages. Fourth, I indicate ways that accounting academics can address the implications of the subprime crisis in their research and teaching.

Keywords: Subprime crisis, credit crunch, fair value accounting, securitization

JEL Classifications: G21, M41, M44

Working Paper Series