Revisiting Fair Value Accounting as a Magnifier of Financial Crises

In an earlier paper titled ‘Mark-to-market accounting as a magnifier of financial crises’, we advocated that fair value or mark-to-market accounting magnifies financial crises by creating a feedback loop between figures from financial reports and financial markets. We proposed a simple method for assessing how overpriced the US stock market is, which included a comparison between fixed base indexes of the S&P 500 and nominal US GDP. In this paper, we reiterate the role that fair value accounting is expected to play in both the creating and bursting of financial bubbles, putting it in the context of theories of ‘reflexivity’ and ‘almost self-fulfilling equilibria’. We reassess the level of the US stock market, showing that a substantial stock market bubble (the third in the last two decades) has been formed recently and that significant market corrections may happen in 2016.