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One Cheer for Credit Rating Agencies: How the Mark-to-Market Accounting Debate Highlights the Case for Rating-Dependent Regulation


John P. Hunt


University of California, Davis - School of Law; Berkeley Center for Law, Business and the Economy

January 22, 2009

60 S.C. L. Rev. 749 (2009)

Abstract:     
Mark-to-market (or fair value) accounting rules for financial assets came under sustained attack in 2008, with commentators blaming these rules for up to 70 percent of the financial crisis. The underlying argument was that reporting declining market values for assets would force sales of those assets, which in turn would depress market values and force more sales in an accounting-driven death spiral. A review of major financial failures and bailouts during the crisis casts grave doubt on this assertion. Although marking to market as provided by collateral provisions of bilateral trading contracts has been important, no major firms appear to have been done in by accounting rules.

The scenario of an externally triggered death spiral would be much more plausible if regulators relied principally on market marks to determine capital requirements for regulated firms. In that case, the reported values would actually have bite and force sales. This is important because regulation based on credit spreads - mark-to-market regulation - is the principal alternative that has been offered to the use of credit ratings in financial regulation. The specter of a regulatory death spiral triggered by mark-to-market regulation highlights the theoretical problems involved in regulating based on unadjusted credit spreads. If capital regulation is going to be based on credit risk, regulators cannot escape from the need for human credit risk analysis by relying simply on market spreads. There is likely to be a continuing regulatory need for the discipline rating agencies are supposed to practice.

Number of Pages in PDF File: 27

Keywords: rating agencies, mark to market accounting, fair value accounting, capital regulation, financial crisis

JEL Classification: G18, G28, M41, M44, G33

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Date posted: January 23, 2009 ; Last revised: February 19, 2013

Suggested Citation

Hunt, John P., One Cheer for Credit Rating Agencies: How the Mark-to-Market Accounting Debate Highlights the Case for Rating-Dependent Regulation (January 22, 2009). 60 S.C. L. Rev. 749 (2009). Available at SSRN: http://ssrn.com/abstract=1331633

Contact Information

John P. Hunt (Contact Author)
University of California, Davis - School of Law ( email )
Martin Luther King, Jr. Hall
Davis, CA 95616-5201
United States
(530) 752-5052 (Phone)
HOME PAGE: http://ratingagencylawblog.wordpress.com/
Berkeley Center for Law, Business and the Economy ( email )
2440 Bancroft Way
Room 308
Berkeley, CA 94704
United States
HOME PAGE: http://www.law.berkeley.edu/centers/bclbe/
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