Money & Banking Ch.12 HW
The debt-deflation process is the process of _____________________________________ that can increase the severity of an economic downturn. Part 2 The debt-deflation process contributed to the severity of the Great Depression by ____________ the real interest rate and the real value of debts, which _________ the burden on borrowers and led to ________ loan defaults.
increasing bankruptcies and defaults, increasing, increased, more
In academic research published before he entered government, Fed Chairman Ben Bernanke wrote: [In] a system without deposit insurance, depositor runs and withdrawals deprive banks of funds for lending; to the extent that bank lending is specialized or information sensitive, these loans are not easily replaced by nonbank forms of credit. Source: Ben S. Bernanke, Essays on the Great Depression, Princeton, NJ: Princeton University Press, 2000, p. 26. What does it mean to say that bank lending is "information sensitive"? A. Banks acquire information to decide if borrowers are creditworthy. B. Savers can easily withdraw their deposits based on the information about the yield. C. Banks' lending is highly sensitive to the information about the interest rate. D. None of the above. Part 2 Nonbank forms of credit A. refer to credit from providers other than banks. B. are credits issued by the Fed. C. refer to credits issued by one commercial bank to another commercial bank. D. are credits issued by the U.S. Treasury. Part 3 Why would bank lending being "information sensitive" make it difficult to replace with nonbank forms of credit? A. Providers of credit are able to provide risk assessment just as well as banks. B. Nonbanks have economies of scale or some other advantage in evaluating the riskiness of loans. C. Banks have economies of scale or some other advantage in evaluating the riskiness of loans. D. Both B and C are correct. Part 4 Does Bernanke's observation help to explain the role bank panics played in the severity of the Great Depression? A. Yes, Bernanke's observation helps to explain the role bank panics played in the severity of the Great Depression. B. No, Bernanke's observation doesn't help to explain the role bank panics played in the severity of the Great Depression. C. When thousands of banks failed, it became difficult for their customers to obtain credit, thus exacerbating the severity of the Great Depression. D. Both A and C are correct.
A. Banks acquire information to decide if borrowers are creditworthy. A. refer to credit from providers other than banks. C. Banks have economies of scale or some other advantage in evaluating the riskiness of loans. D. Both A and C are correct.
The classic account of bank panics was published in 1879 by Walter Bagehot, editor of the Economist, in his book Lombard Street: "In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them." Source: Walter Bagehot, Lombard Street: A Description of the Money Market, New York: John Wiley, 1999 (first published 1873), p. 51. Part 2 All of the following are reasons why one bank failure might lead to many bank failures, except: A. If multiple banks have to sell the same assets, the prices of those assets are likely to rise. B. Depositors have an incentive to withdraw their money from their banks to avoid losing it should their banks be forced to close. C. Banks will be forced to sell loans and securities to raise money to pay off depositors. D. Depositors of other banks may become concerned that their banks might also have problems. Part 3 What are the two main ways in which the government can keep one bank failure from leading to a bank panic? A. A central bank can act as a borrower of last resort and insure deposits. B. A central bank can act as a borrower of last resort, and the government can insure deposits. C. A central bank can act as a lender of last resort and insure deposits. D. A central bank can act as a lender of last resort, and the government can insure deposits.
A. If multiple banks have to sell the same assets, the prices of those assets are likely to rise. D. A central bank can act as a lender of last resort, and the government can insure deposits.
In his memoirs, Herbert Hoover described the reaction of his Treasury Secretary to the Great Depression: First was the "leave it alone liquidationists" headed by Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Source: Herbert Hoover, The Memoirs of Herbert Hoover: Volume 3: The Great Depression, 1929-1941, New York: Macmillan, 1952, p. 30. What does "liquidate" mean in this context? A. Liquidate means to let prices fall to their equilibrium level. B. Liquidate means to encourage struggling firms to expand. C. Liquidate means to redistribute the assets and property of a business. D. Both A and B are correct. Part 2 Can these views help to explain the actions by the Fed during the early years of the Great Depression? A. Yes. The Fed and the government did absolutely nothing to help the economy during the Great Depression. B. Yes, to an extent, because the Federal Reserve was acting on the predominant economic model of the time, which said that the economy will self-adjust and any attempt to intervene will either do nothing or create negative consequences. C. No, these views don't help to explain the actions by the Fed. The Federal Reserve was acting on the predominant economic model of the time, which said that the economy needed government intervention in order to recover. D. There is not enough information to answer the question.
A. Liquidate means to let prices fall to their equilibrium level. Your answer is correct. B. Yes, to an extent, because the Federal Reserve was acting on the predominant economic model of the time, which said that the economy will self-adjust and any attempt to intervene will either do nothing or create negative consequences.
Question content area Part 1 [Related to the Making the ConnectionLOADING...] In their book This Time Is Different, Carmen Reinhart and Kenneth Rogoff conclude: "An examination of the aftermath of severe postwar financial crises shows that they have had a deep and lasting effect on asset prices, output, and employment." Source: Carmen M. Reinhart and Kenneth S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton, NJ: Princeton University Press, 2009, p. 248. Part 2 Why should a recession connected with a financial crisis be more severe than a recession that did not involve a financial crisis? A. When financial institutions fail, credit markets can be damaged, and the amount of borrowing, and hence economic activity, can decrease, further affecting real output. B. A recession that includes a financial crisis is generally more complex and has more severe consequences, such as increasing asset prices and lending, which affects the economy for a longer time period than a traditional recession. C. Both A and B are correct. D. None of the above. A recession connected with a financial crisis will be less severe than a recession that did not involve a financial crisis.
A. When financial institutions fail, credit markets can be damaged, and the amount of borrowing, and hence economic activity, can decrease, further affecting real output.
A columnist writing in the Wall Street Journal observed: "Franklin D. Roosevelt's March 1933 inaugural line 'that the only thing we have to fear is fear itself' was inspiring, but wrong. There was plenty to fear, not least the deflation that then gripped the nation." Prices fall when a country experiences deflation, so isn't deflation good for consumers? A. Yes, allowing the price level to fall is necessary before an economic recovery can begin. B. No, borrowers would be hurt by the higher real interest rates and higher real value of debts that deflation causes. C. Yes, deflation decreases prices, so when prices are falling, the purchasing power of money increases. D. It depends. The lower price level is always good for consumers as long as it doesn't lead to bank runs. Part 2 If nominal interest rates remain unchanged during a period of deflation, then when inflation rates are __________, the real interest rate in the economy will __________. Part 3 Was deflation during the early 1930s good or bad for firms? A. It was good for firms because the lower price level effectively increased consumer spending. B. It was bad for firms that were borrowers because it effectively raised interest rates. C. It was good for firms that were borrowers because it effectively lowered interest rates. D. Uncertain, as the outcome depends on how consumers responded to the lower prices of the firms.
B. No, borrowers would be hurt by the higher real interest rates and higher real value of debts that deflation causes. decreasing, increase B. It was bad for firms that were borrowers because it effectively raised interest rates.
[Related to the Chapter Opener] In a paper written in April 2010, looking back at the financial crisis, former Fed Chair Alan Greenspan argued: At least partly responsible [for the severity of the financial collapse] may have been the failure of risk managers to fully understand the impact of the emergence of shadow banking that increased financial innovation, but as a consequence, also increased the level of risk. The added risk had not been compensated by higher capital. Source: Alan Greenspan, "The Crisis," April 15, 2010, p. 21. How did the emergence of shadow banking increase the risk to the financial system? (Check all that apply.) A. Nonbank financial institutions are required to maintain the equivalent of reserve requirements. B. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long. C. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow long and lend short. D. In the event of a nonbank financial institution run, there is no equivalent of the FDIC. Part 2 What does Greenspan mean that "the added risk had not been compensated by higher capital"? In order to compensate for the risk, Greenspan believes that nonbank financial institutions should have voluntarily A. decreased excess reserves. B. decreased their debt. C. increased the interest rate. D. increased their capital.
B. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long. & D. In the event of a nonbank financial institution run, there is no equivalent of the FDIC. D. increased their capital.
An article in the New York Times published just after the Fed helped to save Bear Stearns from bankruptcy noted: If Bear Stearns failed, for example, it would result in a wholesale dumping of mortgage securities and other assets onto a market that is frozen and where buyers are in hiding. This fire sale would force surviving institutions carrying the same types of securities on their books to mark down their positions. Source: Gretchen Morgenson, "Rescue Me: A Fed Bailout Crosses a Line," New York Times, March 18, 2008. Why did Bear Stearns almost fail? (Check all that apply.) A. because Bear liquidated assets in order to pay back long-term loans B. because Bear liquidated assets in order to pay back short-term loans C. because lenders declined to renew Bear's short-term loans D. because lenders lost faith in Bear's ability to pay back long-term loans E. because lenders lost faith in Bear's ability to pay back short-term loans Part 2 How did the Federal Reserve rescue Bear Stearns? The Federal Reserve arranged a buyout of Bear Stearns by A. JP Morgan Chase. B. Bank of America. C. Lehman Brothers. D. Citibank. Part 3 The debt-deflation process is the process of _________________________ that can increase the severity of an economic downturn. Part 4 Does this process provide any insight into why the Federal Reserve rescued Bear Stearns? (Check all that apply.) A debt-deflation process A. does not provide any insight into why the Federal Reserve rescued Bear Stearns. B. pushes up the price of those assets which other investment banks hold, thus worsening their balance sheets. C. would occur if Bear Stearns goes bankrupt and has to sell its assets. D. pushes down the price of those assets which other investment banks hold, thus worsening their balance sheets, which in turn can accelerate bankruptcies.
B. because Bear liquidated assets in order to pay back short-term loans & C. because lenders declined to renew Bear's short-term loans & E. because lenders lost faith in Bear's ability to pay back short- A. JP Morgan Chase. falling asset prices C. would occur if Bear Stearns goes bankrupt and has to sell its assets. & D. pushes down the price of those assets which other investment banks hold, thus worsening their balance sheets, which in turn can accelerate bankruptcies.
In a paper written in April 2010, looking back at the financial crisis, former Fed Chairman Alan Greenspan wrote: Some bubbles burst without severe economic consequences, the dotcom boom and the rapid run-up of stock prices in the spring of 1987, for example. Others burst with severe deflationary consequences. That class of bubbles ... appears to be a function of the degree of debt leverage in the financial sector, particularly when the maturity of debt is less than the maturity of the assets it funds. Source: Alan Greenspan, "The Crisis," April 15, 2010, p. 10. What does Greenspan mean by "debt leverage"? A. purchasing assets with personal funds B. borrowing and purchasing assets with borrowed funds C. financing investments by issuing stocks D. purchasing other firms' derivatives Part 2 Which of the following could be a negative implication if "the maturity of the debt is less than the maturity of the assets it funds"? A. If the debt is not renewed, or rolled over, the asset side of the balance sheet becomes unsustainable. B. A debt could be renewed on very bad conditions: lower costs, longer terms, etc. C. It is possible that a company will face a situation when it has to pay the debt after it will get profit from the investments. D. All of the above. Part 3 Does Greenspan's analysis provide insight into why the Fed during his tenure may have been reluctant to take action against asset bubbles? A. Greenspan's analysis doesn't provide insight into why the Fed during his tenure may have been reluctant to take action against asset bubbles. B. Bubbles always cause severe economic consequences. So, Greenspan's analysis is unsustainable. C. If the Fed followed Greenspan's analysis, their actions should have been sharply different. D. If Greenspan believes that most bubbles burst without severe economic consequences, then, yes, it would explain the Fed's actions.
B. borrowing and purchasing assets with borrowed funds A. If the debt is not renewed, or rolled over, the asset side of the balance sheet becomes unsustainable. D. If Greenspan believes that most bubbles burst without severe economic consequences, then, yes, it would explain the Fed's actions.
he financial writer Sebastian Mallaby observed about hedge funds that: ... leverage also made hedge funds vulnerable to shocks: If their trades moved against them, they would burn through thin cushions of capital at lightning speed, obliging them to dump positions fast—destabilizing prices. Source: Sebastian Mallaby, More Money Than God, New York: Penguin Press, 2010, p. 10. What does a hedge fund's trades "moving against it" mean? "Moving against it" means that A. traders insist on decreasing the leverage of the funds. B. if a hedge fund bets one way and the price moves another away, it has to exit the position fast. C. traders are leaving the hedge fund. D. None of the above. "Moving against it" in the passage has no special meaning. Part 2 Why would a fund's trade moving against it cause it to burn through its capital? A. Hedge funds are highly leveraged, and a margin is generally required for their trades. B. Capital serves as margin, so capital is used as a cushion between losses. C. Both A and B are correct. D. None of the above. A fund's trade moving against it does not cause it to burn through its capital because the leverage of hedge funds is low. Part 3 What is the connection between a fund's being highly leveraged and its having a "thin cushion of capital"? Leverage __________ a trading position, __________the ratio of capital to assets. This __________ both gains and losses and ________ the capital "cushion" for losses. Part 4 What does a fund's "dumping its positions" mean? (Check all that apply.) A. Selling after capital runs out. B. Selling before capital runs out. Your answer is correct. C. Selling after a margin call. D. Selling before a margin call. Part 5 Why might a fund's dumping its positions cause prices to be destabilized? Prices of what? Because such large positions are being sold, it _________ the prices of _____________________.
B. if a hedge fund bets one way and the price moves another away, it has to exit the position fast. C. Both A and B are correct. magnifies, reducing, magnifies, reduces B. Selling before capital runs out. decreases, assets the fund holds
Former Federal Reserve Chair Ben Bernanke has observed that; "Even a bank that is solvent under normal conditions can rarely survive a sustained run." Source: Ben S. Bernanke, The Courage to Act: The Financial Crisis and Its Aftermath, New York: W.W. Norton, 2015, p. 45. Part 2 What does Bernanke mean by "solvent under normal conditions"? A. The value of a bank's assets is less than the value of its liabilities, so its net worth, or capital, is negative. B. The value of a bank's assets is less than the value of its liabilities, so its net worth, or capital, is positive. C. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive. D. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is negative. Part 3 What does he mean by a "sustained run"? Why can't a bank by itself survive a sustained run? A. By "sustained run," Bernanke means a bank run that lasts for a significant period of time. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are long term and not easily liquidated. B. By "sustained run," Bernanke means a bank run that lasts for a short period of time. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are short term and easily liquidated. C. By "sustained run," Bernanke means a process by which simultaneous deposits result in a bank closing. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposits and its assets are long term and not easily liquidated. D. By "sustained run," Bernanke means a process by which simultaneous devaluation of assets result in a bank closing. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are short term and easily liquidated.
C. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive. A. By "sustained run," Bernanke means a bank run that lasts for a significant period of time. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are long term and not easily liquidated.
What is meant by the "fragility" of commercial banking? The "fragility" of commercial banking means that ________. A. banks borrow long to lend short and are relatively liquid on any given day B. commercial banks tend to be smaller banks that could be forced to shut down at any moment C. banks borrow short to lend long and are relatively illiquid on any given day D. commercial banks tend to be larger banks that could be forced to shut down at any moment Part 2 Does a bank have to be insolvent to experience a run? A. No, bank runs usually occur when banks lend out more money than they have in reserves. B. No, bank runs are caused by bank panics, which can occur whether a bank is insolvent or not. C. Yes, banks runs are caused by illiquidity, which can occur only if the bank is insolvent. D. Yes, since this is the only time that depositors lose enough confidence in their banks and withdraw all their funds.
C. banks borrow short to lend long and are relatively illiquid on any given day B. No, bank runs are caused by bank panics, which can occur whether a bank is insolvent or not.
What is a lender of last resort? A. A lender of last resort is an institution that serves as an ultimate source of credit to which banks can turn during a panic. B. The Federal Reserve acts as a lender of last resort. C. Is an entity that seeks to stop a bank failure from turning into a bank panic by making sure solvent institutions can meet their depositors' withdrawal demands. D. All of the above. Part 2 How is being a lender of last resort connected to the too-big-to-fail policy? (Check all that apply.) A. The too-big-to-fail policy and the lender of last resort have to provide liquidity to banks during bank panics. B. The too-big-to-fail policy and the lender of last resort strive to prevent systemic risk, where the failure of a few firms leads to the widespread failure of solvent banks. C. The too-big-to-fail policy and the lender of last resort strive to promote "moral hazard" in the banking system. D. A lender of last resort is not connected to the too-big-to-fail policy.
D. All of the above. A. The too-big-to-fail policy and the lender of last resort have to provide liquidity to banks during bank panics. & B. The too-big-to-fail policy and the lender of last resort strive to prevent systemic risk, where the failure of a few firms leads to the widespread failure of solvent banks.
An article in the New York Times quoted former Fed Chairman Alan Greenspan as arguing in 2010: "The global house price bubble was a consequence of lower interest rates, but it was long-term interest rates that galvanized home asset prices, not the overnight rates of central banks, as has become the seemingly conventional wisdom." Source: Sewell Chan, "Greenspan Concedes That the Fed Failed to Gauge the Bubble," New York Times, March 18, 2010. A house price bubble A. means that the decline in the housing market caused a decrease not only in spending on residential construction, but also affected markets for furniture and appliances. B. means that asset prices have increased beyond the point that could be justified by property appraisers. C. means that asset prices have decreased below the point that could be justified by fundamental evaluation. D. occurs when house prices move beyond their fundamental values. Part 2 Why would long-term interest rates have a closer connection to house prices than overnight interest rates? A. The Fed can control and change long-term interest rates more easily than short-term interest rates. B. Mortgage companies generally markup mortgages 2−3% above the 10−year Treasury bond yield. C. Housing purchases are typically short-term investments. D.The average holding of a house is 30 years. The average holding of a house is 30 years. Part 3 Why would it matter to Greenspan whether low long-term interest rates were more responsible for the housing bubble than low short-term interest rates? A. Buying a house is linked with short-term borrowings, which were insured by mortgage-backed securities. B. Mortgage-backed securities are usually short-term loans. C. To lessen the Federal Reserve's responsibility under Greenspan's watch as Chairman for causing, at least partially, the housing bubble with low interest rates. D. All of the above.
D. occurs when house prices move beyond their fundamental values. B. Mortgage companies generally markup mortgages 2−3% above the 10−year Treasury bond yield. C. To lessen the Federal Reserve's responsibility under Greenspan's watch as Chairman for causing, at least partially, the housing bubble with low interest rates.
What is "contagion"? What role does it play in bank panics? Contagion is when ________. A. one bank lends excess reserves to another bank. If there are not enough banks participating in the sytem, it can cause a bank panic. B. a bank is only able to stabilize its balance sheet by buying securities. This can help prevent a bank panic. C. the failure of one bank causes the failure of another bank it does business with. It is unrelated to a bank panic. D. the failure of one bank causes runs on other banks. If multiple banks experience bank runs, the result is a bank panic.
D. the failure of one bank causes runs on other banks. If multiple banks experience bank runs, the result is a bank panic.
