Historic cost accounting remained in the ascendancy in the US from the 1940s right though to the early 1970s. But from the mid-1970s onwards, accounting standard-setters began to embrace fair value measurement, first in the context of banks’ portfolios of equities and other marketable securities. 5 By the late 1980s, there was widespread recognition that traditional accounting approaches were obscuring the real value of securities and derivatives. US experience during the Savings and Loan crisis in the mid-1980s provided further impetus. Forbearance, including about the valuation of assets and liabilities, was widely believed to have been a cause of the build-up of problems among the thrifts. 6 In 1989, Congress passed the Financial Institutions Recovery, Reform and Enforcement Act (FIRREA), tightening valuation standards among banks and bringing them closer to fair values. In the same year, the International Accounting Standards Committee (IASC) commenced a project to assess the measurement and disclosure of financial instruments. These too were to suffer a set-back. By 1990, recession had taken hold in the US, with lending contracting sharply. As in 1938, the US economy was suffering “financial headwinds”. As in 1938, the Fed were quick to call for a relaxation of prudential and valuation standards to head-off pressures on banks. 7 And as in 1938, the upshot was a concerted move by the then-President, George Bush, relaxing examination and valuation standards. 8 For the second time, fair value had been returned to its box. And so to the present day – the third phase.

The exception is the bust of 2007–08, where the fall in value has been both greater and faster. It is plausible that fire-sales, aggravated in part by marking to market, may have contributed to this dynamic. The fair value agenda So how do these considerations relate to the debate on international accounting standards? At present, these stand at a crossroads. In the US (through the Financial Accounting Standards Board (FASB)) and internationally (through the International Accounting Standards Board (IASB)), standard-setters are reviewing their treatment of financial instruments. Substantive decisions are planned during 2010. Within the IASB, a review of IAS39 is underway, with consultation on a new standard, IFRS9. The fair value debate is at the heart of the new proposals. One key dimension is valuation, where IFRS9 proposes a combination of amortised cost and fair values, with clear criteria to determine the suitability of assets for each category. In the US, FASB is expected to issue consultation proposals that would tend to reinforce the use of fair value among US banks. A second dimension is provisioning. The concern here is that the use of provisions based on incurred losses means that impairments are recognised too late, thereby contributing to pro-cyclicality of loan supply. 23 In response, the IASB has issued a consultation paper proposing that provisions be set on an expected loss basis. These proposals are currently being explored by regulators internationally. 19  For example, see Plantin, Sapra and Shin (2008) and Allen and Carletti (2007) for a theoretical exposition of these dynamics.