consider four scenarios. consider first a bank making a single loan. in the first period, amortised cost and fair valuations of this loan will be equal. expected cashflows will in both cases be discounted at the prevailing market discount rate. to the extent emh is violated – for example, because the market discount rate is too low – both accounting concepts will result in asset over - valuation. both concepts will be equally imprudent. in other words, credit cycles that cause failures of emh contaminate bank asset valuations irrespective of the accounting convention. consider next a bank with a portfolio of two loans, one initiated when assets prices were priced correctly, the other when they were over - valued. in this situation, amortised cost and fair values will value the asset portfolio differently. because market prices are applied to the whole asset stock, fair value will tend to result in greater recorded overvaluation. in other words, marking to market is more susceptible to valuation cycles than amortised cost. third, consider a situation where, having been over - valued, the market price of the second loan corrects back to equilibrium. fair values now deliver the correct valuation of the entire asset portfolio. amortised cost measures, meanwhile, will continue to give a misleadingly bullish account of the second loan ’ s valuation, since this will be discounted at the artificiallylow discount rate used at initiation. in other words, in this set of circumstances the tables are turned, with fair values giving a more accurate and prudent measure of valuation. finally, if instead of correcting to equilibrium, assume market prices over - correct – say, because of an overshoot in illiquidity premia of the type witnessed during crisis. it is then no longer clear which valuation metric is preferable. both will be inaccurate to some degree but in opposite directions – the amortised cost measure suggesting valuations which are “ too high ”, while fair value will suggest valuations which are “ too low ”. the greater the initial misalignment in asset prices, and the smaller their subsequent overshoot, the greater the likelihood of fair values being preferred over amortised cost and vice - versa. ultimately, however, this is an empirical question. in general terms, however, the point is clear : efficient markets are not necessary but may be sufficient to justify the use of fair value principles. better accounting for expected losses what is clear from

##agating banking failure during the great depression. 20 the evidence of such dynamics during this crisis is more mixed. some studies have claimed this effect was limited to banks with large trading portfolios ; 21 others that it has been significant and wide - ranging across the financial sector. 22 perhaps the truth lies somewhere in between, with some market and institutions affected and others immune. chart 8 plots commercial property values in the uk since 1920. there are five discernible boom and bust cycles in commercial property, signified by the dotted lines. chart 9 looks at the cumulative falls in value during the bust. in four of the cases, the bust was similarly timed and sized. 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. for example, see plantin, sapra and shin ( 2008 ) and allen and carletti ( 2007 ) for a theoretical exposition of these dynamics. “ under such circumstances, any runs on banks for whatever reason became to some extent self - justifying, whatever the quality of assets held by banks. banks had to dump their assets on the market, which inevitably caused