Article

Question 1

In their article Laux/Leuz discuss the role fair value accounting
played during the subprime crisis. Explain in brief terms what they
mean with “procyclical effects” of fair value accounting? How
does procyclicality of fair value accounting work? (2 points)

Answer 1

Fair value accounting worsens swings
in the financial system because In times of economic upswings “asset
write-ups” allow banks to increase their leverage in booms and
create a market bubble.

In times of economic downturns the “write-offs” can cause a downward spiral (write-offs lead to sales and these
lead in turn to even higher write-offs

Question 2

What is a market bubble?

Answer 2

A rapid rise in the price of stocks or other assets that is not justified by fundamentals

Question 3

What is an asset write up?

Answer 3

An increase made to the book value of an asset because the CA is smaller than the fair market value

Question 4

What is an asset write off?

Answer 4

the reduction of its value

Question 5

FVA is also called…

Answer 5

mark to market accounting

Question 6

What is the theory of the second best?

Answer 6

Theory of the Second Best” cautions, removing one imperfection in an imperfect world does not necessarily lead to welfare improvements