Fair Value Accounting, Fragile Bank Balance Sheets and Crisis: A Model

50 Pages Posted: 27 Jan 2014 Last revised: 31 Jul 2014

See all articles by Phillip de Jager

Phillip de Jager

University of Cape Town - Department of Finance and Tax

Date Written: January 25, 2014

Abstract

A topic of recent interest in accounting research has been the investigation of the role of fair value accounting (FVA) in the global financial crisis. This research focused on finding a link during the crisis time-period and often states that “accounting is only a messenger”. The model presented in this paper emphasises finding the link before the crisis and “accounting as money.” Use is made of an accounting model of the economy due to the inability of standard models of monetary transmission to incorporate global financial crisis characteristics such as feedback effects, systemic risk and the centrality of the financial sector in the crisis. The model shows FVA in banks to be an accelerator that amplifies the financial cycle upswing. Feedback effects noted in the model include changes in the demand for financial instruments and changes in demand in the real economy. Minsky-like, crisis is shown to be endogenous to the model, working through the fragility of balance sheets in the real sector as well as in the financial sector. Bank balance sheet fragility is caused by bad capital driving out good capital, banks reaching for yield and the inversion of the yield curve. The model shows that the practice of not meeting rising credit demand with increasing credit supply is an essential control mechanism in the financial cycle.

Keywords: financial crisis, endogenous money, transmission mechanism, fair value accounting

JEL Classification: M41, E51

Suggested Citation

de Jager, Phillip, Fair Value Accounting, Fragile Bank Balance Sheets and Crisis: A Model (January 25, 2014). Accounting, Organizations and Society, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2385306

Phillip De Jager (Contact Author)

University of Cape Town - Department of Finance and Tax ( email )

Private Bag X3
Rondebosch, 7701
South Africa

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