How to mark-to-market when there is no market

Abstract

At the center of the global financial crisis of 2007-2008 was the collapse of American International Group, brought on by extensive unhedged positions in derivatives, such as credit default swaps, and possibly exacerbated by mark-to-market accounting rules. Even though these rules generally produce the most realistic valuations of derivatives, a heated debate broke out over their application in a dislocated market. The foremost concern was that forcing financial institutions to mark down assets to their current market prices actually causes further declines. Regulators largely dismissed such concerns, but acknowledged that the existing standards could use additional clarification and modification. Many scholarly studies have since concurred that the rules should not be replaced, but suggest that additional measures should be taken to avoid their potential procyclical effects. © 2011 Macmillan Publishers Ltd.