GAAP and IFRS define fair value in a similar way, which is a price at which an asset and liability can be traded with a willing counterparty in an orderly manner. Both accounting frameworks provide measurement approaches at differentiated levels. Level 1: prices can be observed on active market, which are used to measure the value of assets and liabilities, a practice called mark-to-market. Level 2: when there is no active market, prices are assessed by using models with observable parameters as inputs, a process called mark-to-model. Measurement approach used on level 3 is similar to the mark-to-model approach, but it involves unobservable parameters and model assumptions as inputs. Both IFRS and GAAP require disclosure of the adoption of fair value approaches and specific assumptions as well as risk exposures and sensitivities.

The problems of fair value accounting have been exposed by the current crisis. First, compared with the historical cost approach, fair value accounting intensifies market fluctuations. While the fair value approach is more dynamic and can better reflect the real time value of assets and liabilities, it also magnifies the changes in their values and increases the volatility of returns through the profit and loss account as a consequence. As a result of the massive collateralized securities they held, financial institutions registered mounting unrealized losses which actually involved no cash flow under the fair value rule. Though these losses were only meaningful in accounting, such astronomical book losses distorted investors' expectations and formed a vicious cycle of prices tumbling - asset write-down ?C panic selling ?C further prices slumps. Second, the poorly guided adoption of fair value in non-active markets exacerbated market volatility. As defined, the using of fair value approaches must be based on the prerequisite of orderly trading. At times of crisis, as a large number of institutions were forced to liquidate their assets, prices developed under this situation did not meet the prerequisite for fair value measurement. However, due to the lack of specific guidelines on dealing with such circumstances, reporting entities had to conduct fair value measurement on the basis of unreasonable market prices, which magnified book losses and exacerbated the vicious cycle.

We could say, in a normal situation or in a low frequency band, mark-to-market is a negative feedback loop. However, in an extreme situation or high frequency band, mark-to-market mechanism can not catch the changing phase. When phase lag is larger than 90º, a negative feedback loop can become a positive feedback loop in characteristics. In this situation, what we need to do is to cut off this loop, thus we need a circuit breaker. We can resume the system when it returns to normal condition. In economic system, we need to put into place a sort of circuit-breaker mechanism to stem the pro-cyclicality caused by mark-to-market and fair value accounting in specific situations.

3) Internal rating based (IRB) approach under Basel II