Understanding the mark-to-market meltdown
Credit valuations service sector heats up
What is fair value? Financial Accounting Standard 157 is quite prescriptive, defining it as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates".
FAS 157 puts in place a framework for fair value measurement and disclosure. Perhaps the most important feature in FAS 157 is the requirement to set out financial statements in three levels that describe the reliability of the inputs used to establish fair value. Fitch describes it as the fair value hierarchy. So Level 1 is quite straightforward, as the prices used are identical to the input and discovered in something like a public exchange. It gets quite complicated for Level 2 assets and liabilities, because the prices used might be inferred from an index or another security with similar attributes to the one being measured. Fair value measurements on Level 3 assets are purely model-driven, consisting of unobservable inputs, and have understandably swollen as markets have grown increasingly illiquid and disorderly.
Determining a fair market value in benign conditions is a very different process to when the backdrop is more hostile.