Minsky’s financial instability hypothesis,accounting information and the 2007

Abstract

This paper examines the financial crisis of 2007–9 in the UK and US in terms of the financial instability hypothesis (FIH), a theory of boom, bust and financial crises. It is shown that in a similar way to the crises of 1866 and 1987 (Barnes, 2007) the FIH provides an important depiction of the 2007–9 crisis and how it came about. However, it does not recognize: (1) the role of accounting information and how it may contribute to boom and bust and be used to change perceptions and mislead; and (2) the likelihood of fraud and financial swindles, all features of the 2007–9 crisis.

Keywords

big bath accounting crash fair value accounting financial crisis 2007–9 fraud informational asymmetry mark to market Minsky

Get full access to this article

View all access options for this article.

References

Abarbanell

Lehavy

(2003), “Can Stock Recommendations Predict Earnings Management and Analysts’ Earnings Forecast Errors?”, Journal of Accounting Research, Vol.41, No.1, pp.1–31.

Ahmed

A.S.

Takeda

Thomas

(1999), “Bank Loan Loss Provisions: A Re-examination of Capital Management, Earnings Management and Signaling Effect”, Journal of Accounting and Economics, Vol.28, No.1, pp.1–25.

Ball

(2008), “Don’t Blame the Messenger … or Ignore the Message”, available at: http://www.chicagobooth.edu/email/chicago_on/ShootingTheMessenger10.12.2008.pdf

Barnes

(2007), “Minsky’s Financial Instability Hypothesis: Information Asymmetry and Accounting Information: Events Surrounding the UK Financial Crises of 1866 and 1987”, Accounting History, Vol.12, No.1, pp.29–53.

Barnes

(2009), Stock Market Efficiency, Insider Dealing and Market Abuse, Aldershot: Gower Press.

Barnes

Ward

(1999), “The Consequences of Deregulation: A Comparison of the Experiences of UK Building Societies with those of US Savings and Loan Associations”, Crime, Law and Social Change, Vol.31, pp. 209–44.

Bauman

Halsey

(2001), “Do Firms Use the Deferred Tax Asset Valuation Allowance to Manage Earnings?”, Journal of American Taxation Association, Vol.23, Supplement, pp.27–48.

Beatty

Petroni

(2002), “Earnings Management to Avoid Earnings Declines Across Publicly and Privately Held Banks”, The Accounting Review, Vol.77, No.3, pp.547–70.

Beaver

Engel

(1996), “Discretionary Behavior with Respect to Allowances for Loan Losses and the Behavior of Security Prices”, Journal of Accounting and Economics, Vol.22, Nos.1–3, pp.177–206.

10.

Bhat

(1996), “Banks and Income Smoothing: An Empirical Analysis”, Applied Financial Economics, Vol.6, No.6, pp.505–10.

11.

Bitner

L.N.

Dolan

R.C.

(1996), “Assessing the Relationship Between Income Smoothing and the Value of the Firm”, Quarterly Journal of Business and Economics, Vol.35, No.1, pp.16–36.

12.

Bryan

Lilien

S.B.

Sarath

(2010), “Countering Opportunism in Structuring and Valuing Transactions: The Case of Securitizations”, Journal of Accounting, Auditing & Finance, Vol.25, No.2, pp.289–321.

13.

Buckmaster

(2001), Development of the Income Smoothing Literature, 1893– 1998: A Focus on the United States, Oxford: Elsevier.

14.

Burgstahler

Dichev

(1997), “Earnings Management to Avoid Earnings Decreases and Losses”, Journal of Accounting and Economics, Vol.24, No.1, pp.99–126.

15.

Burgstahler

Eames

(2003), “Earnings Management to Avoid Losses and Earnings Decreases: Are Analysts Fooled?”, Contemporary Accounting Research, Vol.20, No.2, pp.253–94.

16.

Cameron

Stephens

(1991), “The Treatment of Non-Recurring Items in the Income Statement and their Consistency with FASB Concept Statements”, Abacus, Vol.27, No.2, pp.81–96.

17.

Centralbank (2009), Minister’s Statement – Anglo Irish Bank, 15.1.2009, available at http://www.finance.gov.ie/viewdoc.asp?DocID=5627

18.

Christensen

T.E.

Paik

G.H.

Stice

E.K.

(2008), “Creating a Bigger Bath Using the Deferred Tax Valuation Allowance”, Journal of Business Finance and Accounting, Vol.35, Nos.5–6, pp.601–25.

19.

Davidson

(2008), “Is the Current Financial Distress Caused by the Subprime Mortgage Crisis a Minsky Moment? Or Is It the Result of Attempting to Securitize Illiquid Non-commercial Mortgage Loans?”, Journal of Post Keynesian Economics, Vol.30, No.4, pp.669–76.

20.

Degeorge

Patel

Zeckhauser

(1999), “Earnings Management to Exceed Thresholds”, Journal of Business, Vol.72, No.1, pp.1–33.

21.

Docking

D.S.

Hirschey

Jones

(1997), “Information and Contagion Effects of Bank Loan-loss Reserve Announcements”, Journal of Financial Economics, Vol.43, pp.219–39.

22.

Elliot

J.A.

Hanna

J.D.

(1996), “Repeated Accounting Write-Offs and the Information Content of Earnings”, Journal of Accounting Research, Supplement, Vol.34, No.3, pp.135–55.

23.

Fiechter

(2011), “The Effects of the Fair Value Option Under IAS 39 on the Volatility of Bank Earnings”, Journal of International Accounting Research, Vol.10, No.1, pp.85–108.

24.

Fiechter

Meyer

(2009), “Big Bath Accounting using Fair Value Measurement Discretion during the Financial Crisis”, SSRN Working Paper, available at: http://ssrn.com/abstract=1522122

25.

Fields

T.D.

Lys

T.Z.

Vincent

(2001), “Empirical Research on Accounting Choice”, Journal of Accounting and Economics, Vol.31, Nos.1–3, pp.255–307.

26.

Financial Accounting Standards Board (FASB) (2006), Fair Value Measurements, Statement of Financial Accounting Standards No. 157, Northwalk, CT: FASB.

27.

Financial Accounting Standards Board (FASB) (2007), Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115, Statement of Financial Accounting Standards No. 157, Northwalk, CT: FASB.

28.

Financial Crisis Inquiry Commission (FCIC, 2011), The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, available at: http://www.fcic.gov/report

29.

Forbes

(2009), “End Mark to Market”, 23 March, available at: http://www.forbes.com/2009/03/20/steve-forbes-mark-to-market-intelligent-investing-market.html

30.

Fuerman

R.D.

(2009), “Bernard Madoff and the Solo Auditor Red-flag”, Journal of Forensic and Investigative Accounting, Vol.1, No.1, pp.1–38.

31.

Furlong

Knight

(2010), “Loss Provisions and Bank Charge-offs in the Financial Crisis: Lesson Learned”, FRBSF Economic Letters, No.16.

32.

Goel

A.M.

Thakor

A.V.

(2003), “Why Do Firms Smooth Earnings?” Journal of Business, Vol.76, No.1, pp.151–92.

33.

Gorton

G.B.

(2009a), “The Subprime Panic”, European Financial Management, Vol.15, No.1, pp.10–46.

34.

Gorton

G.B.

(2009b), “Information, Liquidity, and the (Ongoing) Panic of 2007”, American Economic Review, Vol.99, No.2, pp.567–72.

35.

Healy

P.N.

(1985), “The Effect of Bonus Schemes On Accounting Decisions”, Journal of Accounting and Economics, Vol.7, Nos.1–3, pp.85–107.

36.

Healy

P.M.

Wahlen

J.M.

(1999), “A Review of the Earnings Management Literature and Its Implications for Standard Setting”, Accounting Horizons, Vol.13, No.4, pp.365–83.

37.

Holthausen

R.W.

Larcker

D.F.

Sloan

R.G.

(1995), “Annual Bonus Schemes and the Manipulation of Earnings”, Journal of Accounting and Economics, Vol.19, No.1, pp.29–74.

38.

Holthausen

Leftwich

(1983), “The Economic Consequences of Accounting Choice: Implications of Costly Contracting and Monitoring”, Journal of Accounting and Economics, Vol.5, pp.77–117.

39.

Hughes

P.A.

Jeffers

A.E.

(2008), “The Misvaluation of Mortgage-backed Assets in the Subprime Debacle”, Journal of Academy of Business and Economics, Vol.8, No.2, pp.56–65.

40.

Huizinga

Laeven

(2009), “Accounting Discretion of Banks During a Financial Crisis”, International Monetary Fund Working Paper, WP/09/207.

41.

Keys

Mukherjee

Amit

Vig

(2008), ‘Securitization and screening: evidence from subprime mortgages’, London Business School, working paper.

42.

Keys

Mukherjee

Seru

Vig

(2010), “Did Securitization Lead to Lax Screening? Evidence from Subprime”, Quarterly Journal of Economics, Vol.125, No.1, pp.307–62.

43.

Keynes

J.M.

(1936), The General Theory of Employment, Interest and Money, London: Macmillan Press.

44.

Kindleberger

C.P.

Aliber

R.Z.

(2005), Manias, Panics, and Crashes: A History of Financial Crises, 5th edition, Basingstoke: John Wiley & Sons.

45.

Kirschenheiter

Melumad

N.D.

(2002), “Can ‘Big Bath’ and Earnings Smoothing Co-exist as Equilibrium Financial Reporting Strategies?”, Journal of Accounting Research, Vol.40, No.3, pp.761–96.

46.

Laux

Leuz

(2009), “The Crisis of Fair-Value Accounting: Making Sense of the Debate”, Accounting, Organizations and Society, Vol.34, Nos.6–7, pp.826–34.

47.

Laux

Leuz

(2010), “Did Fair-Value Accounting Contribute to the Financial Crisis?”, Journal of Economic Perspectives, Vol.24, No.1, pp.93–118.

48.

Loutskina

Strahan

(2009), “Securitization and the Declining Impact of Bank Finance on Loan Supply: Evidence From Mortgage Originations”, Journal of Finance, Vol.64, No.2, pp.861–89.

49.

McIlroy

(2006), “A Return to Objectivity: The Interpretation of Dishonest Assistance in Barlow Clowes”, Journal of International Banking and Financial Law, Vol.21, No.3, pp.126–7.

50.

Mian

Amir

(2009), “The Consequences of Mortgage Credit Expansion: Evidence from the Mortgage Default Crisis”, Quarterly Journal of Economics, Vol.124, No.4, pp.1449–96.

51.

Minsky

H.P.

(1964), “Longer Waves in Financial Relations: Financial Factors in the More Severe Recessions”, American Economic Review, Vol.54, No.2, pp.324–35.

52.

Minsky

H.P.

(1969), “Private Sector Asset Management and the Effectiveness of Monetary Policy: Theory and Practice”, Journal of Finance, Vol.24, No.2, pp.223–38.

53.

Minsky

H.P.

(1975), John Maynard Keynes, New York: Columbia University Press.

54.

Minsky

H.P.

(1977), “A Theory of Systemic Fragility”, in Altman

E.I.

Sametz

A.W.

(eds.) Financial Crises: Institutions and Markets in a Fragile Environment, New York: John Wiley and Sons.

55.

Minsky

H.P.

(1982), “The Financial – Instability Hypothesis: Capitalist Processes and the Behavior of the Economy”, in Kindleberger

C.P.

Laffargue

(eds.) Financial Crises: Theory, History, and Policy, Cambridge: Cambridge University Press.

56.

Minsky

H.P.

(1989), “Comment on ‘Economic Implications of Extraordinary Movements in Stock Prices’ by B.M. Friedman and D.A. Laibson”, Brookings Papers on Economic Activity, Vol.2, No.3, pp.173–89.

57.

Moehrle

(2002), “Do Firms Use Restructuring Charge Reversals to Meet Earnings Targets?”, The Accounting Review, Vol.77, No.2, pp.397–414.

58.

Moyer

S.E.

(1990), “Capital Adequacy and Ratio Regulations and Accounting Choices in Commercial Banks”, Journal of Accounting and Economics, Vol.13, No.2, pp.123–54.

59.

Pistole

(2009), Deputy Director, FBI, US Department of Justice, Statement before the US Senate Committee Hearing entitled “The Need for Increased Fraud Enforcement in the Wake of the Economic Downturn”, 11 February 2009, available at: http://judiciary.senate.gov/hearings/testimony.cfm?id=e655f9e2809e5476862f735da1438779&wit_id=e655f9e2809e5476862f735da1438779-1-1

60.

Pozen

R.C.

(2009), “Is it Fair to Blame Fair Value Accounting for the Financial Crisis?”, Harvard Business Review, November, pp.84–92.

61.

Riedl

E.J.

(2004), “An Examination of Long-Lived Asset Impairments”, The Accounting Review, Vol.79, No.3, pp.823–52.

62.

Ronen

Yaari

(2008), Earnings Management: Emerging Insights in Theory, Practice and Research, New York: Springer.

63.

Ryan

S.G.

(2008a), “Accounting in and for the Subprime Crisis”, The Accounting Review, Vol.83, No.6, pp.1605–38.

64.

Ryan

S.G.

(2008b), Fair Vale Accounting: Understanding the Issues raised by the Credit Crunch, New York: Council of Institutional Investors.

65.

SEC (2008), Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark to Market Accounting, available at: http://www.sec.gov/news/studies/2008/marktomarket123008.pdf

66.

Serious Organised Crime Agency (SOCA) International Mass-Marketing Fraud Working Group (2010), Mass-Marketing Fraud: A Threat Assessment, London: SOCA.

67.

Song

C.J.

(2008), “An Evaluation of FAS 159 Fair Value Option: Evidence from the Banking Industry”, Working Paper, Virginia Polytechnic Institute and State University.

68.

Valukas

A.R.

(2010), Report of the Examiner in the Chapter 11 Proceedings of Lehman Brothers Holdings Inc., available at http://lehmanreport.jenner.com

69.

Wilson

(2007), “Have We Reached a ‘Minsky moment’?”, Money Week, 5 April.

Minsky’s financial instability hypothesis,accounting information and the 2007–9 financial crisis in the UK and US

Abstract

Keywords

Get full access to this article

References