Open main menu

Wikipedia β

Changes

Financial crisis of 2007–2008

12 bytes added, 3 months ago
m
Incorrect pricing of risk: better
The pricing of risk refers to the [[Risk premium|incremental compensation]] required by investors for taking on additional risk, which may be measured by interest rates or fees. Several scholars have argued that a lack of transparency about banks' risk exposures prevented markets from correctly pricing risk before the crisis, enabled the mortgage market to grow larger than it otherwise would have, and made the financial crisis far more disruptive than it would have been if risk levels had been disclosed in a straightforward, readily understandable format.<ref name="ssrn" /><ref name="papers.ssrn" />
 
For a variety of reasons, market participants did not accurately measure the risk inherent with financial innovation such as MBS and CDOs or understand its effect on the overall stability of the financial system.<ref name="Declaration of G20" /> For example, the pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. Banks estimated that $450bn450 billion of CDO were sold between "late 2005 to the middle of 2007"; among the $102bn102 billion of those that had been liquidated, JPMorgan estimated that the average recovery rate for "high quality" CDOs was approximately 32&nbsp;cents on the dollar, while the recovery rate for [[mezzanine capital|mezzanine]] CDO was approximately five cents for every dollar.<ref name="TPMBLOG1">{{cite web|date=March 2, 2009|url=http://tpmcafe.talkingpointsmemo.com/talk/blogs/paulw/2009/03/the-power-of-belief.php|title=paulw's Blog &#124; Talking Points Memo &#124; The power of belief|publisher=Tpmcafe.talkingpointsmemo.com|accessdate=November 11, 2009|deadurl=yes|archiveurl=https://web.archive.org/web/20090406005046/http://tpmcafe.talkingpointsmemo.com/talk/blogs/paulw/2009/03/the-power-of-belief.php|archivedate=April 6, 2009|df=mdy-all}}</ref>
 
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>