Econ 330 CH. 12

Why is a financial crisis likely to lead to a contraction in economic​ activity? A. A disruption in the financial system diminishes the flow of funds from savers to borrowers. B. Disruptions in the financial system decreases asymmetric​ information, thereby decreasing the associated problems of adverse selection and moral hazard. C. Those that borrow funds to finance productive investment opportunities will have a greater opportunity to obtain financing. D. None of the above are correct.

A. A disruption in the financial system diminishes the flow of funds from savers to borrowers.

Which of the following statements support your​ answer? ​(Select all that​ apply.) A. Deposit insurance creates moral hazard incentives encouraging risk taking on the part of banks B. Deposit insurance is unable to prevent the effects of an asset price decline or the spread of a financial crisis to international financial markets. C. Deposit insurance is unable to prevent the fire sales resulting from a run on the shadow banking system. D. Deposit insurance increases information asymmetry between banks and borrowers.

A. Deposit insurance creates moral hazard incentives encouraging risk taking on the part of banks B. Deposit insurance is unable to prevent the effects of an asset price decline or the spread of a financial crisis to international financial markets.

What would be the result of an increase in haircuts on​ collateral? A. Financial institutions would engage in fire sales on assets. B. Increasing haircuts would allow a financial institution to borrow a higher level of funds. C. With increased collateral​ requirements, balance sheets of firms and households would greatly improve. D. The shadow banking system would play an even more prominent role in financial markets.

A. Financial institutions would engage in fire sales on assets.

What role does weak financial regulation and supervision play in causing financial​ crises? A. It allows financial institutions a better opportunity to engage in excessive​ risk-taking behavior. B. It creates higher interest​ rates, as government expenditures will tend to increase. C. It reduces the risk that financial institutions will make bad loans. D. It helps establish tighter rules and regulations for lending activities

A. It allows financial institutions a better opportunity to engage in excessive​ risk-taking behavior.

Some countries do not advertise that a system of deposit insurance like the FDIC​ (The Federal Deposit Insurance​ Corporation) in the United States exists in their banking system. Which of the following explain why some countries do not advertise that a system of deposit insurance exists in their banking​ system?​ (Select all that​ apply.) A. Not advertising deposit insurance may reduce the problem of moral​ hazard, which is created by a system of deposit insurance. B. The information about the presence of a system of deposit insurance makes depositors and bank clients less likely to monitor a​ bank's activities. C. The disclosing of information about the presence of a system of deposit insurance restricts banks from engaging in hedge fund trading with derivatives. D. Not advertising deposit insurance may increase the problem of adverse selection between lenders and potential depositors.

A. Not advertising deposit insurance may reduce the problem of moral​ hazard, which is created by a system of deposit insurance. B. The information about the presence of a system of deposit insurance makes depositors and bank clients less likely to monitor a​ bank's activities.

Identify the differences between the United​ States' experiences during the Great Depression and the financial crisis of​ 2007-2009. ​(Check all that​ apply.) A. The source of asset minus price increases was different for both episodes. B. Unemployment was a larger factor during the recent financial crisis with only minor implications during the Great Depression. C. The recent crisis resulted in more significant declines in GDP than the Great Depression. D. The banking system was not hit as hard during the Great Depression as it was during the 2007 minus 2009 financial crisis. E. No bank panic occurred in 2007 dash 2009 as opposed to the Great Depression.

A. The source of asset minus price increases was different for both episodes. E. No bank panic occurred in 2007 dash 2009 as opposed to the Great Depression.

When the risk that some banks might fail​ increases, depositors may not have enough information to determine whether their bank is a good one or one of the banks at greater risk to fail. Depositors have an incentive to withdraw their deposits before the bank runs out of funds. If this becomes a widespread​ occurrence, it is known​ as: A. a bank panic. B. adverse selection. C. moral hazard. D. debt deflation.

A. a bank panic.

Regardless of the original source of the financial​ crisis, all credit booms end in a credit crash because of A. an increase in adverse selection and moral hazard in the loan market. B. massive government deficits. C. corruption in the mortgage industry. D. collateralized debt obligations.

A. an increase in adverse selection and moral hazard in the loan market.

Given the data on stock prices shown in Figure 2, any detrimental wealth effect upon consumption attributable to the stock market A. occurred roughly over the​ 1930-1932 period and to a lesser extent in 1937. B. ended with the presidency of FDR. C. cannot be ascertained without data on stock dividends. D. lasted throughout the​ 1929-1940 period.

A. occurred roughly over the​ 1930-1932 period and to a lesser extent in 1937.

Advances in computer technology and new statistical techniques led to the development of subprime mortgages. A. True B. False

A. True

Housing prices boomed from 2002 to​ 2006, and then prices started to decline in​ 2006, falling by more than​ 30%, which led to defaults by subprime mortgage holders. Effect A Subprime borrowers found the value of the house fell below the amount of the mortgage B Defaults on houses declined during this period C Banks began to restrict the availability of credit to households Which of the effects listed above may have helped trigger the subprime financial crisis starting in​ 2007? A. A and B. B. A and C. C. B and C. D. ​A, B, and C.

B. A and C.

Which of the following factors apart from securitization was responsible for the Great Recession of​ 2007-2009? A. An increase in the federal funds rate. B. An increase in funds lent to subprime borrowers. C. A sudden rise in equity prices.

B. An increase in funds lent to subprime borrowers.

Which of the following statements is true of financial​ frictions? A. Financial frictions help avoid the problem of moral hazard in financial markets. B. Financial frictions are a set of conditions that prevents financial markets from effectively assigning funds to the best investment opportunities. C. Financial frictions are a set of conditions that prevents financial markets from undertaking​ high-risk investment. D. Financial frictions help avoid the problem of adverse selection in financial transactions.

B. Financial frictions are a set of conditions that prevents financial markets from effectively assigning funds to the best investment opportunities.

Which of the following statements is likely to contradict the idea that the Fed was responsible for the housing price bubble of the​ mid-2000s in the United​ States? ​(Select all that​ apply.) A. The Fed set the federal funds rate at an extremely low level. B. Lowering of lending standards. C. Capital inflows from India and China coupled with no attractive investment opportunities. D. The Fed was not stringent enough in regulating and monitoring financial intermediaries.

B. Lowering of lending standards. C. Capital inflows from India and China coupled with no attractive investment opportunities.

Why would haircuts on collateral increase sharply during a financial​ crisis? A. There is an increase in demand for loans. B. There is an increase in the uncertainty over the value of assets. C. There is a lack of credit standards and rules. D. There is a decrease in the number of nondepository financial firms.

B. There is an increase in the uncertainty over the value of assets.

A financial crisis occurs​ when: A. financial frictions decrease sharply. B. a particularly large disruption to information flows occurs in financial markets. C. capital is allocated to its most productive uses. D. there are predictable market disruptions.

B. a particularly large disruption to information flows occurs in financial markets.

The​ Dodd-Frank Act of 2010 is the most​ comprehensive: A. tax reform legislation since the Civil War. B. financial reform legislation since the Great Depression. C. financial reform legislation since the Civil War. D. tax reform legislation since the Great Depression.

B. financial reform legislation since the Great Depression.

Which of the following is not a factor that commonly initiates financial​ crises? A. ​Asset-price booms and busts. B. The mismanagement of financial liberalization and innovation. C. The increased uncertainty that occurs when a major financial institution fails. D. Increases in government regulations that make it harder to manage the risks of financial assets.

D. Increases in government regulations that make it harder to manage the risks of financial assets.

Which of the following is not a reason why bank failures worsen financial​ crises? A. As bank panics​ occur, banks begin to sell so many assets that it can lower asset prices so much that even good banks become insolvent. B. A reduction in the number of banks operating reduces the amount of lending that can take​ place, which creates less economic activity and in turn makes borrowing more difficult. C. Bank panics reduce the amount of asymmetric​ information, which makes it more difficult to lend funds. D. The closing of many banks worsen adverse selection and moral hazard problems.

C. Bank panics reduce the amount of asymmetric​ information, which makes it more difficult to lend funds.

Which of the following is true of​ securitization? A. It is a process that drives the prices of financial instruments above their fundamental economic values. B. It is a process that converts​ high-risk financial instruments into​ default-free financial instruments. C. It is a process that converts a series of financial instruments into marketable securities.

C. It is a process that converts a series of financial instruments into marketable securities.

Which of the following statements are likely to be in favor of the idea that the Fed was responsible for the housing price bubble in the​ mid-2000s in the United​ States? ​(Select all that​ apply.) A. Lowering of lending standards. B. Capital inflows from India and China coupled with no attractive investment opportunities. C. The Fed set the federal funds rate at an extremely low level. D. The Fed was not stringent enough in regulating and monitoring financial intermediaries.

C. The Fed set the federal funds rate at an extremely low level. D. The Fed was not stringent enough in regulating and monitoring financial intermediaries.

Which of the following did not help prevent the financial crisis of​ 2007-2009 from becoming a​ depression? A. The Federal​ Reserve's use of monetary policy to lower the federal funds rate target. B. The creation of new​ programs, such as lending to investment banks and purchasing commercial​ paper, by the Federal Reserve. C. The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve. D. The use of nonconventional policy by the Federal Reserve to create term auction facilities

C. The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve.

Financial crises A. often begin with financial liberalization or innovation B. is followed by an economic boom. C. occur when information flows in financial markets experience a particularly large disruption. D. occur when financial frictions decrease sharply.

C. occur when information flows in financial markets experience a particularly large disruption.

A​ well-functioning financial​ system: A. acts as a barrier to efficient allocation of capital. B. causes financial frictions to increase in an economy. C. solves asymmetric information problems. D. creates unpredictable market disruptions

C. solves asymmetric information problems.

How can a bursting of an​ asset-price bubble in the stock market trigger a financial crisis? A. A reduction in asset prices causes lenders to become more cautious and reduce the amount of loans they make B. A reduction in asset prices causes a serious deterioration in borrowing​ firms' balance sheets C. A reduction in asset prices causes borrowing firms to have less to lose so they are willing to take on additional risk D. All of the above are correct

D. All of the above are correct

Why is the​ originate-to-distribute business model subject to the​ principal-agent problem? A. Once the mortgage broker earns his or her​ fee, the broker does not care if the borrower makes good on his payment B. The mortgage broker has little incentive to ensure the borrower is​ credit-worthy, since loans will be sold as​ mortgage-backed securities C. The more volume the broker​ originates, the more he or she makes D. All of the above are correct

D. All of the above are correct

How did financial innovations in mortgage markets contribute to the​ 2007-2009 financial​ crisis? A. Borrowers could get mortgage loans with little or no money down and could borrow more money relative to the value of the house they were buying and relative to their incomes than allowed with traditional mortgages. B. Information technology lowered the cost of packaging numerous subprime mortgages into​ mortgage-backed securities that could be sold in financial​ markets, attracting more funds into mortgage finance. C. Advances in information technology and new statistical techniques lowered the cost of evaluating the risk of mortgages to subprime borrowers who did not meet the standards for traditional mortgage loans. D. All of the above are correct.

D. All of the above are correct.

Which of the following is associated with asymmetric information in a financial​ crisis? A. Adverse selection can occur if lenders must select from a pool of bad credit risks. B. There is a lack of information about one or more of the parties involved in a transaction. C. Moral hazard could occur when only borrowers know if the funds will be used to finance​ high-risk activities. D. All of the above are correct.

D. All of the above are correct.

How did the global financial crisis promote a sovereign debt crisis in​ Europe? A. Surging budget deficits raised fears that governments might default on their​ debt, causing interest rates on that debt to soar. B. Government outlays rose as bailouts became necessary for failing financial institutions. C. The contraction in economic activity accompanying the financial crisis sharply reduced tax revenues for many governments. D. All of the above. E. B and C only.

D. All of the above.

Which of the following is not a​ principal-agent problem resulting from the originate-to-distribute business​ model? A. When investors purchase​ mortgage-backed securities, it is in their best interest to purchase​ low-risk securities, which may be contrary to the mortgage​ brokers' best interest. B. When investors are willing to purchase bundled​ mortgage-backed securities, it is in the best interest of mortgage brokers to make lots of loans. C. When mortgage brokers do not intend to hold the mortgage loans they​ make, they have little reason to be concerned whether the borrower can pay off the loan. D. Since mortgage brokers do not intend to hold the mortgage loans they​ make, they take extra care to gather as much information as possible about the borrower.

D. Since mortgage brokers do not intend to hold the mortgage loans they​ make, they take extra care to gather as much information as possible about the borrower.

Why does a financial crisis ultimately cause a substantial reduction in economic​ activity? A. The financial crisis causes a fiscal deficit. B. The government responds to the crisis with excessive regulation. C. Only corrupt bankers survive the crisis. D. The resulting credit crash severely reduces investment for productive activities.

D. The resulting credit crash severely reduces investment for productive activities.

Which of the following does not cause a reduction in the net worth of the borrowing firm in a loan​ market? A. an unanticipated decline in the value of the domestic currency when the​ firm's debt is denominated in terms of a foreign currency B. asset​ write-downs on the​ firm's balance sheet C. a decline in the stock market that drops the value of the firm D. an unanticipated increase in the price level that reduces the value of the firm's liabilities

D. an unanticipated increase in the price level that reduces the value of the firm's liabilities

When a fire sale​ occurs, A. adverse selection and moral hazard are reduced. B. uncertainty is reduced. C. financial frictions are low. D. banks may become insolvent.

D. banks may become insolvent.

Deposit insurance prevents financial crises. Is this statement always​ true?

No

Was the process of securitization solely responsible for the Great Recession of​ 2007-2009?

No

In the years following​ 1930, the successful operation of the​ self-correcting mechanism was blocked by the ongoing and severe _________

decline in prices

One of the​ Fed's functions is to be a lender of last resort. Given the chain reaction emanating initially from bank losses in agricultural regions and later spreading throughout the economy over​ 2+ years, the​ Fed's efforts to provide assistance might be characterized briefly as __________

grossly inadequate

In seeking to curb the excessive speculation fueling the late 1920s stock market​ boom, given the events of late​ 1929, the Fed apparently took actions that were too ____

stringent

An increase in adverse selection and moral hazard in credit markets ________ bank lending

tends to decrease