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Financial crisis of 2007–2008

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Incorrect pricing of risk: consistent punctuation
Another example relates to [[AIG]], which insured obligations of various financial institutions through the usage of credit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay money to party A in the event party B defaulted. However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September 2008. US taxpayers provided over $180&nbsp;billion in government support to AIG during 2008 and early 2009, through which the money flowed to various counterparties to CDS transactions, including many large global financial institutions.<ref>{{cite news|url=https://www.bloomberg.com/apps/news?pid=20601109&sid=aKKRHZsxRvWs&refer=home|title=Bloomberg-Credit Swap Disclosure Obscures True Financial Risk|publisher=Bloomberg|date=November 6, 2008|accessdate=February 27, 2009|deadurl=yes|archiveurl=https://www.webcitation.org/68F8QZzuT?url=http://www.bloomberg.com/apps/news?pid=newsarchive|archivedate=June 7, 2012|df=mdy-all}}</ref><ref>{{cite web|last=Byrnes|first=Nanette|url=http://www.businessweek.com/bwdaily/dnflash/content/mar2009/db20090316_859460.htm?chan=top+news_top+news+index+-+temp_top+story|title=Business Week-Who's Who on AIG List of Counterparties|work=BusinessWeek|date=March 17, 2009|accessdate=May 1, 2010}}</ref>
 
The [[Financial Crisis Inquiry Commission]] (FCIC) made the major government study of the crisis. It concluded in January 2011:<blockquote>The Commission concludes AIG failed and was rescued by the government primarily because its enormous sales of credit default swaps were made without putting up the initial collateral, setting aside capital reserves, or hedging its exposure – aexposure—a profound failure in corporate governance, particularly its risk management practices. AIG's failure was possible because of the sweeping deregulation of over-the-counter (OTC) derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products, including capital and margin requirements that would have lessened the likelihood of AIG's failure.<ref>{{cite book|author=Phil Angelides|title=Financial Crisis Inquiry Report|url=https://books.google.com/books?id=QIKfTVrhNfMC&pg=PA352|year=2011|publisher=DIANE Publishing|page=352}}</ref><ref>{{cite book|author=Jerry M. Rosenberg|title=The Concise Encyclopedia of The Great Recession 2007–2012|url=https://books.google.com/books?id=8YSYIHuSX2oC&pg=PA244|year=2012|publisher=Scarecrow Press|page=244}}</ref><ref>{{cite book|author1=Asli Yüksel Mermod|author2=Samuel O. Idowu|title=Corporate Social Responsibility in the Global Business World|url=https://books.google.com/books?id=KVqRAAAAQBAJ&pg=PA127|year=2013|publisher=Springer|page=127}}</ref></blockquote>The limitations of a widely used financial model also were not properly understood.<ref>{{cite web|last=Regnier|first=Pat|url=http://moneyfeatures.blogs.money.cnn.com/2009/02/27/the-financial-crisis-why-did-it-happen/|title=New theories attempt to explain the financial crisis – Personal Finance blog – Money Magazine's More Money|publisher=Moneyfeatures.blogs.money.cnn.com|date=February 27, 2009|accessdate=November 11, 2009|deadurl=yes|archiveurl=https://web.archive.org/web/20090304024927/http://moneyfeatures.blogs.money.cnn.com/2009/02/27/the-financial-crisis-why-did-it-happen/|archivedate=March 4, 2009|df=mdy-all}}</ref><ref name="Felix1">{{Cite news|last=Salmon|first=Felix | publication-date = February 23, 2009|title=Recipe for Disaster: The Formula That Killed Wall Street|magazine=[[Wired.com]]|issue=17.03|url=https://www.wired.com/techbiz/it/magazine/17-03/wp_quant|accessdate=March 8, 2009}}</ref> This formula assumed that the price of CDS was correlated with and could predict the correct price of mortgage-backed securities. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.<ref name="Felix1" /> According to one wired.com article: {{quotation|Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of [[David X. Li|Li's]] formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril... Li's [[Gaussian copula]] formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.<ref name="Felix1" /> }}
 
As financial assets became more complex and harder to value, investors were reassured by the fact that the international [[bond rating]] agencies and bank regulators accepted as valid some complex mathematical models that showed the risks were much smaller than they actually were.<ref name=RISKS1>{{cite news|author=Floyd Norris|url=https://www.nytimes.com/2008/11/25/business/25assess.html?hp|title=News Analysis: Another Crisis, Another Guarantee|work=The New York Times|date=November 24, 2008|accessdate=April 22, 2011}}</ref> [[George Soros]] commented that "The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility."<ref name=WORSTCRISIS>{{Cite news|last=Soros|first=George | author-link = George Soros | publication-date = January 22, 2008|title=The worst market crisis in 60 years|newspaper=Financial Times | publication-place = London, UK|url=http://www.ft.com/cms/s/0/24f73610-c91e-11dc-9807-000077b07658.html?nclick_check=1|accessdate=March 8, 2009}}</ref>