Mark-to-market regulatory accounting when securities markets are stressed: Lessons from the financial crisis of 2007-2009

► Theory suggests counting some unrealized losses against bank capital may be counterproductive. ► Bhat et al. provide some of the first empirical validation of this theory. ► Banks sell into negative liquidity shocks when liquidity-based unrealized losses affect capital. ► Inefficient sales cease when banks get discretion to not count unrealized losses against capital. ► Shareholders, bondholders, and taxpayers all benefit from giving banks more discretion.