It is interesting that there was evidence of financial markets making their own switch in valuation convention during the course of the crisis. As funding maturities shortened, the probability of asset liquidation rose. It became rational, then, for investors to begin valuing even banking book assets at market prices, as in Chart 7. For a time, this process appeared to generate its own downward dynamic, with shortening maturities and falling asset prices eroding the impliedly mark-to-market solvency position of banks in a liquidity/solvency loop. Some have argued this downward dynamic itself justifies switching-off fair values. But the perils of doing so are clear. Persisting with an inappropriate valuation metric may give an inaccurate picture of banks’ true solvency position. It will also reduce banks’ incentives to adjust funding structures to guard against such a dynamic. It is precisely such risk management incentives that appear to explain the relative success of some firms, including Goldman Sachs, during this crisis. Therein may lie a lesson. Conclusion The fortunes of fair value have waxed and waned historically, particularly at crisis time. So it is no surprise that fair value is under attack today. We may be at yet another pivot point. With financial markets still thick with fog and filthy air, now would be an unfortunate time to starve balance sheets of the sunlight provided by fair values. Blocking out the sun or, worse still, claiming it revolves around the earth will not serve banks or regulators well in the longer run.

Restoring traditional accounting principles sounds desirable, provided the (Italian) values we import are Pacioli rather than Mussolini. At the same time, it needs to be recognised that too much sunlight can scorch. That means applying appropriate filters to fair values, screening out their harmful rays. Rethinking valuation practices across firms, asset classes and countries, better to capture expected losses, is one important such filter. Recognising the liability as well as asset characteristics of institutions may be another. We need to ensure these changes do not erode fair value principles, as that would result in the baby being thrown out with the bathwater. Making fair values less foul ought to advantage both investors and regulators. It would protect fair value from lightening strikes when the next financial thunderstorm breaks. References Allen, F and Carletti (2007), “Market-to-Market Accounting and Liquidity Pricing”, Wharton Financial Institutions Centre Working Paper 06–15. Billings, M and F Capie (2009), “Transparency and Financial Reporting in mid-20th Century British Banking”, Accounting Forum, 38–53. Bronk, R (2009), The Romantic Economist, Cambridge University Press. 12  BIS Review 28/2010  Financial Accounting Standards Board (2009), “Financial Instrument: Improvements to Recognition and Measurement”, Financial Statement Presentation of Financial Instruments, 13 August 2009 (Board meeting handout). Federal Deposit Insurance Corporation (1997), History of the Eighties – Lessons for the Future. Friedman, M and A J Schwartz (1963), A Monetary History of the United States, 1867–1960, Princeton University Press. Goethe, J W (1796), Wilhelm Meisters Lehrjahre.