Fair Value Accounting and Financial Stability

Accounting is sometimes seen just as a veil leaving the economic fundamentals unaffected. Indeed, in the context of completely frictionless markets, where assets trade in fully liquid markets and there are no problems of perverse incentives, accounting would be irrelevant since reliable market prices would be readily available to all. Just as accounting is irrelevant in such a world, so would any talk of establishing and enforcing accounting standards. To state the proposition the other way round, accounting is relevant only because we live in an imperfect world, where markets are not always fully liquid and incentives may be distorted. In such an imperfect world, transaction prices may not be readily available. Even those prices that are available may not correspond to the hypothetical market prices that would prevail in frictionless perfect markets. Therefore, when we debate issues regarding accounting, it is important to be clear on the nature and consequences of the imperfections