I finally got around to reading the hefty government-mandated report (part of the Emergency Economic Stabilization Act of 2008) recently released by the SEC on mark-to-market accounting, and I will point out the highlights:
Although not mandated for study by the Act, the Staff believes that it is important to recognize what many believe to be the larger problem in the financial crisis that led to the financial distress at financial institutions other than banks, including The Bear Stearns Companies, Inc. (“Bear Stearns”), Lehman Brothers Holdings Inc. (“Lehman”), and Merrill Lynch & Co., Inc. (“Merrill Lynch”).
Rather than a crisis precipitated by fair value accounting, the crisis was a “run on the bank” at certain institutions, manifesting itself in counterparties reducing or eliminating the various credit and other risk exposures they had to each firm. This was, in part, the result of the massive de-leveraging of balance sheets by market participants and reduced appetite for risk as margin calls increased, putting enormous pressure on asset prices and creating a “self-reinforcing downward spiral of higher haircuts, forced sales, lower prices, higher volatility, and still lower prices.” The trust and confidence that counterparties require in one another in order to lend, trade, or engage in similar risk-based transactions evaporated to varying degrees for each firm very quickly.
What would have been more than sufficient in previous stressful periods was insufficient in more extreme times.
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