Bank valuation and accounting discretion during a financial crisis

This paper shows that banks overstate the value of distressed assets and their regulatory capital during the US mortgage crisis. Real estate-related assets are overvalued in banksʹ balance sheets, especially those of bigger banks, compared to the market value of these assets. Banks with large exposure to mortgage-backed securities also provision less for bad loans. Furthermore, distressed banks use discretion over the classification of mortgage-backed securities to inflate their books. Our results indicate that banksʹ balance sheets offer a distorted view of the financial health of the banks and provide suggestive evidence of regulatory forbearance and noncompliance with accounting rules.