Deck 19: Financial Crises

Question 1

In a recession, _, which makes _ more likely.

A)loan demand falls; bank panics
B)loan supply rises; insolvency
C)inflation rises; higher interest rates
D)unemployment rises; inflation

Answer 1

loan demand falls; bank panics

Question 2

A fall in asset prices can lead to a(n) , which then leads to further _.

A)jump in inflation; interest rate increases
B)increase in real interest rates; monetary tightening
C)recession; declines in asset prices
D)recession; interest rate increases

Answer 2

recession; declines in asset prices

Question 3

An illiquid bank can become insolvent when it:

A)refuses to make promised payments.
B)sells additional stock to obtain funds.
C)sells assets at fire-sale prices to meet liquidity demands.
D)can extend the due dates of its liabilities.

Answer 3

sells assets at fire-sale prices to meet liquidity demands.

Question 4

Which of the following triggered the Great Depression? I. Bank panics II. The Dust Bow
LIII. The stock market crash

A)I only
B)II only
C)I and III
D)II and III

Question 5

An asset bubble bursts if there is:

A)a panic cycle of asset sales and falling asset prices.
B)a statement from the central bank stating the bubble is over.
C)an excess demand for an asset that raises asset prices.
D)a sharp decrease in interest rates that pricks the asset-price bubble.

Question 6

Which of the following best describes how a fall in asset prices reduces output?

A)Asset crash → number of banks ↓→ loans ↓→ AE ↓→ output ↓
B)Asset crash → wealth ↓→ loans ↑→ inflation ↑→ output ↓
C)Asset crash → wealth ↓→ consumption ↓→ AE ↓→ output ↓
D)Asset crash → risk ↓→ loans ↑→ inflation ↓→ output ↓

Question 7

Generally, when there is a financial crisis, it:

A)becomes a vicious downward cycle.
B)is made worse if it causes a recession.
C)precipitates a decline in asset prices.
D)All of the Answer s are correct.

Question 8

When depositors lose confidence in a bank there is a(n) _ , and the bank faces a .

A)bank surge; credit shortcoming
B)contagion; credit tightening
C)bank run; liquidity crisis
D)increase in vault cash; reduction in its credit rating

Question 9

All financial crises have elements of:

A)insolvency and government corruption.
B)asset price declines and failures of financial institutions.
C)declining liquidity and low interest rates.
D)high inflation and high interest rates.

Question 10

At its peak, unemployment hit _ during the Great Depression.

A)10%
B)17%
C)25%
D)50%

Question 11

Banks lend to:

A)one another.
B)small borrowers.
C)other financial institutions.
D)All of the Answer s are correct.

Question 12

Illiquid financial institutions:

A)have assets that are worth less than their liabilities.
B)do not have immediately available funds to make promised payments.
C)have negative net worth.
D)do not accept deposits or make loans to households.

Question 13

A bank with assets less than liabilities is said to be , while a bank without adequate funds immediately available to make promised payments is said to be _.

A)inflated; inverted
B)inverted; inflated
C)insolvent; illiquid
D)illiquid; insolvent

Question 14

An asset-price decline can be interpreted as:

A)a complete lack of confidence.
B)the offshoot of a liquidity crisis.
C)an asset-price bubble in reverse.
D)government debt default.

Question 15

An investment bank may face _ if _.

A)insolvency; its depositors run on the bank
B)a liquidity crisis; its creditors lose confidence
C)bank runs; the federal government removes deposit insurance
D)moral hazard; the federal government removes deposit insurance

Question 16

A financial institution becomes insolvent when the value of its:

A)assets falls below its liabilities.
B)net worth becomes negative.
C)capital becomes negative.
D)All of the Answer s are correct.

Question 17

It can be said that _ is(are) the cause of an asset bubble.

A)changes in the real economy
B)expectations
C)inflation
D)tight monetary policy

Question 18

When Bank-A fails and it has borrowed from Bank-B:

A)the assets of Bank-B fall and Bank-B also risks insolvency.
B)all Bank-A's deposits are usually covered by deposit insurance.
C)Bank-B generally forgives the debt.
D)Bank-B will buy Bank-A's outstanding debt.

Question 19

Which of the following best describes how bank insolvencies reduce output?

A)Insolvency → wealth ↓→ consumption ↓→ AE ↓→ output ↓
B)Insolvency → number of banks ↓→ loans ↓→ AE ↓→ output ↓
C)Insolvency → investment ↑→ AE ↓→ output ↓
D)Insolvency → risk ↓→ loans ↑→ inflation ↓→ output ↓

Question 20

Like insolvencies in general, _ can spread from one financial institution to another, and these spillovers largely .

A)asset crashes; are pure fiction
B)liquidity crises; are psychological
C)credit crunches; have no real effects
D)housing bubbles; are short lived

Question 21

When Congress established the Federal Reserve in 1913, the Fed's main purpose was to:

A)make federal funds loans. conduct open-
B)market operations. bankroll the
C)government in World War I. act as a
D)lender of last resort.

Question 22

When the Federal Reserve made rescue loans without recourse, if the borrower defaulted, the Fed would be entitled to receive:

A)the amount originally lent to the borrower.
B)only the value of the collateral used to secure the loan.
C)the difference between the amount originally lent and the value of the collateral.
D)the value of the collateral plus the difference between the amount originally lent and the value of the collateral.

Question 23

The phrase "too big to fail" was coined by in 1984.

A)President Ronald Reagan
B)Treasury Secretary Paulson
C)a congressman
D)the president of the International Monetary Fund

Question 24

Ideally, the purpose of providing funds to insolvent banks beyond required insurance payouts is to:

A)transfer funds from taxpayers to financial institutions.
B)give taxpayers ownership in a commercial bank.
C)reward political loyalty.
D)prevent bank failures from multiplying.

Question 25

When the Federal Reserve made rescue loans secured by collateral, but without recourse, these loans were _ , because the Federal Reserve _ if the borrower defaulted.

A)risky; could receive collateral worth less than the amount lent
B)risky; could be forced to make additional loans
C)riskless; would receive full repayment
D)riskless; would receive the collateral

Question 26

In the period 1930-1933, President _ put an end to bank panics, with _.

A)Roosevelt; a bank holiday
B)Hoover; excessive printing of money
C)Kennedy; marshal law
D)Truman; increased government spending

Question 27

When the phrase _ was coined, it referred to _.

A)"too big to fail"; JP Morgan and Bank One
B)"one bank one country"; the Bank of America
C)"laissez-faire"; the Federal Reserve
D)"too big to fail"; Continental Illinois Bank

Question 28

The phrase _ states that large banks facing insolvency must be bailed out to save the financial system.

A)"one bank one country"
B)"too big to fail"
C)"fear is in the eye of the beholder"
D)"laissez-faire" bank markets

Question 29

Treasury purchases of stock in troubled financial institutions during the financial crisis of 2007-2009 are examples of:

A)loans made without recourse.
B)discount loans.
C)equity injections.
D)government giveaways.

Question 30

Discount loans made as lender of last resort are _, while rescue loans made by the Federal Reserve during the financial crisis of 2007-2009 were _.

A)risky loans to prevent illiquidity; riskless loans to prevent insolvency
B)riskless loans made to solvent institutions; risky loans to prevent failure
C)risky loans made to insolvent institutions; riskless loans to prevent failure
D)riskless loans to prevent insolvency; risky loans to solvent institutions

Question 31

To get a loan from the Federal Reserve, a bank must:

A)borrow indirectly from another member bank.
B)borrow directly from the Treasury Department.
C)appeal to the President.
D)apply for the loan at the Fed.

Question 32

When the central bank acts as a lender of last resort, it:

A)requires the borrower to put up collateral.
B)is able to confiscate some of the borrower's assets.
C)requires voting rights of the borrower's board of directors.
D)nationalizes the borrower.

Question 33

Government giveaways to banks make it more likely that financial institutions will:

A)continue to take on excessive risk.
B)believe they will be rescued if they become insolvent.
C)become too big to fail.
D)All of the Answer s are correct.

Question 34

The longer-term indirect cost of government giveaways to banks is the:

A)lost tax revenues.
B)loss of banking industry credibility.
C)worsening of moral hazard.
D)lost transaction deposits.

Question 35

During the bank panics of 1930-1933, about _ of all banks failed.

A)one-half
B)one-third
C)one-fourth
D)one-tenth

Question 36

When a central bank acts as lender of last resort, it , and there is no cost to the .

A)helps a solvent institution facing a liquidity crisis; central bank or taxpayers
B)helps an insolvent institution; borrower
C)helps a bank take over another financial institution; bank being purchased
D)prevents a credit crunch; Treasury Department

Question 37

The short-term direct cost of government giveaways to banks is the:

A)loss of a bank's reputation.
B)political cost to Congress.
C)costs paid by taxpayers.
D)loss of banking autonomy.

Question 38

When government giveaways are provided to banks, the government essentially .

A)gives money to a bank
B)acts as a lender of last resort
C)conducts open market operations
D)makes the institution government owned and operated.

Question 39

Discount loans and Term Auction Facility funds are available to:

A)commercial banks.
B)investment banks.
C)insurance corporations.
D)hedge funds.

Question 40

The advantage of government equity injections into troubled financial institutions rather than government giveaways of funds to financial institutions is that the equity injections may than the government giveaways.

A)cost taxpayers less
B)keep interest rates lower
C)reduce unemployment more
D)end credit crunches sooner

Question 41

As a direct consequence of the value of shares in Reserve Primary Fund "breaking the buck" in 2008, there was:

A)a run on money market funds.
B)Lehman Brothers went bankrupt.
C)the Troubled Asset Relief Program was created.
D)Fannie Mae and Freddie Mac became insolvent.

Question 42

Because the Continental Illinois Bank had the accounts of over small banks, its failure would have _ .

A)10; little impact on the banking system
B)200; bankrupted the FDIC
C)2,000; threatened the failure of many other banks
D)None of the Answer s is correct.

Question 43

One justification for greater regulation of banks than of non-bank financial institutions is the:

A)lower amounts of capital and higher amounts of risky assets held at banks.
B)absence of economy-wide repercussions when non-banks fail.
C)more limited opportunities for excessive risk-taking by non-bank institutions.
D)existence of government insurance of bank deposits.

Question 44

When the Fed makes loans through the Primary Dealer Credit Facility, it lends to:

A)stock brokerage houses.
B)hedge funds.
C)primary dealers in the government securities market.
D)savings and loans.

Question 45

In 2007, the British bank _ suffered a bank run.

A)Northern Rock
B)National Westminster
C)Lloyds
D)Barclays

Question 46

The benefit of stricter financial regulation is while the cost is .

A)the end of securitization; the development of more profitable opportunities
B)increased monitoring of risk-taking behavior; higher executive compensation
C)the prevention of excessive risk-taking; impeding financial innovation
D)lower inflation; higher unemployment

Question 47

Policies that limit the amount of deposits held by one bank, increase capital requirements as bank assets increase, or restrict the number of branches a bank may operate serve primarily as policies to reduce the of financial institutions.

A)size scope
B)insolvency
C)illiquidity

Question 48

In 2007, many banks refused to request a loan because they worried that:

A)it would signal weakness.
B)they wouldn't be able to repay it.
C)they didn't have enough deposits.
D)they would be punished by the Fed.

Question 49

The Treasury used most of the funds allocated by the Troubled Asset Relief Program (TARP) to:

A)purchase mortgage-backed securities.
B)make equity injections into troubled financial institutions.
C)create a new regulatory agency to oversee risky assets.
D)make emergency loans to the FDIC.

Question 50

In 2008, the Fed brokered the sale of the investment bank Bear Stearns to:

A)Citigroup.
B)Bank of America.
C)Wells Fargo.
D)JP Morgan Chase.

Question 51

The 2007-2008 financial crisis began with:

A)hedge funds not being able to pay back their long-term loans.
B)commercial banks losing their bank capital.
C)a sharp increase in the federal funds rate.
D)defaults on subprime mortgages.

Question 52

The potential economic disruption caused by bankruptcies of non-bank financial institutions could be reduced by:

A)establishing a resolution authority.
B)strengthening economies of scale.
C)limiting securitization.
D)abolishing the "too big to fail" doctrine.

Question 53

Insolvent banks while insolvent non-bank institutions .

A)are taken over by the FDIC; are usually taken over by the SEC
B)are taken over by the FDIC; usually declare bankruptcy
C)declare bankruptcy; are usually taken over by the SEC
D)declare bankruptcy; are usually taken over by the FDIC

Question 54

To prevent a financial crisis in 2008, the Fed under Ben Bernanke pursued a series of unorthodox policies; for example, it:

A)expanded its role as lender of last resort.
B)quickly reduced the federal funds rate.
C)arranged a risky loan for the purchase of Bear Stearns.
D)All of the Answer s are correct.

Question 55

In 2007, fears that losses would push banks into insolvency caused a(n) , as banks _.

A)liquidity crisis; became reluctant to loan to each other
B)inflationary spiral; inter-bank real interest rates became negative
C)bank panic; closed their doors to depositors
D)asset-price crash; ceased buying each other's assets

Question 56

Which of the following was not a major Fed policy during the 2007-2008 financial crisis?

A)cuts in the federal funds rate
B)rescue of Lehman Brothers Investment Bank
C)creation of the Primary Dealer Credit Facility
D)creation of the Term Auction Facility

Question 57

To counter the economic downturn in 2008, the Fed:

A)raised the prime lending rate.
B)cut the federal funds rate.
C)increased the discount rate.
D)lowered taxes.

Question 58

In 2006, defaults on subprime mortgages led to losses to and .

A)commercial banks; investment banks
B)mortgage lenders; holders of mortgage-backed securities
C)savings and loans; the U.S. Treasury
D)venture capitalists; the Fed

Question 59

After the 2008 sale of investment bank Bear Stearns, the Fed established the _ to make loans to investment banks.

A)Primary Dealer Credit Facility
B)Term Auction Facility
C)ABCP MMMF Liquidity Facility
D)Commercial Paper Funding Facility

Question 60

In response to the near failure of the investment bank Bear Stearns in 2008, the Fed established the:

A)Term Auction Facility.
B)Primary Dealer Credit Facility.
C)Federal Deposit Insurance Corporation.
D)Securities and Exchange Commission.

Question 61

A key argument against executive compensation practices is that they encourage excessive risk-taking because executives receive large bonuses when profits are high:

A)but do not pay penalties when profits are low.
B)but pay large penalties when profits are low.
C)pay high taxes when profits are high.
D)but do not pay high taxes when profits are low.

Question 62

Ratings agencies have an incentive to inflate ratings because they are paid by the:

A)Federal Reserve.
B)Treasury.
C)Security and Exchange Commission.
D)security issuer.

Question 63

In the aftermath of the Argentine financial crisis, the government announced it would:

A)reduce import tariffs to zero.
B)control budget deficits.
C)lower real interest rates.
D)choose a different inflation target.

Question 64

Requiring financial institutions that arrange risky transactions to hold some of the risk themselves is known as:

A)being "too big to fail." requiring
B)"skin in the game." acting as a
C)"lender of last resort." restricting
D)"economies of scale."

Question 65

A sharp increase in net capital outflow that occurs when asset holders lose confidence in an economy is called:

A)contagion.
B)capital flight.
C)a credit crunch.
D)an asset-price bubble.

Question 66

Which of the following helped speed the economic recovery of Argentina after the financial crisis?

A)A rise in the exchange rate helped keep inflation low.
B)A fall in the exchange rate boosted exports.
C)The government was able to borrow from international lenders.
D)Consumer interest rates fell, boosting firms' profits.

Question 67

When Argentina adopted a _, it lost its ability to conduct .

A)flexible exchange rate; fiscal policy
B)fixed interest rate; monetary policy
C)free trade regime; tax policy
D)currency board; monetary policy

Question 68

The IMF was originally established to:

A)make large loans for development projects in low-income countries.
B)help countries in financial crisis.
C)oversee the fixed exchange rate among the 44 members of the Bretton Woods system.
D)act as a central bank to the members of the United Nations.

Question 69

All of the following are reasons for triggering capital flight in emerging markets except:

A)rising government debt.
B)a decline in commodity prices.
C)political risk.
D)banking problems.

Question 70

The main cause of the Argentinean financial crisis of 2001-2002 was:

A)assassinations of several members of Congress.
B)large government budget deficits.
C)poor bank lending practices.
D)the default on international loans.

Question 71

In 1991, to curb inflation, Argentina set up a _ , which is an extreme version of a fixed exchange rate.

A)currency board
B)fixed interest rate target
C)flat tax on exports
D)dollar-based economy

Question 72

IMF stands for the:

A)Institutional Money and Finance Organization.
B)Investment Money Fund.
C)International Monetary Fund.
D)Inter-Monetary Facility.

Question 73

One proposal for discouraging excessive risk-taking is to require "skin in the game," which means that the financial institution must:

A)be large enough to qualify for "too big to fail treatment."
B)have sufficient collateral to receive loans from the Fed.
C)hold some of the risky transactions themselves.
D)be subject to Federal Reserve regulations.

Question 74

All of the following effects of a financial crisis are shared by emerging markets and industrialized countries except that emerging countries also experience:

A)a liquidity crisis.
B)the bursting of an asset bubble.
C)a sharp depreciation of their real exchange rate.
D)the loss of market liquidity.

Question 75

Emerging markets frequently get hit by the following two effects when they have a financial crisis:

A)a decrease in the real interest rate and in the real exchange rate.
B)capital flight and a falling real interest rate.
C)an increase in the real interest rate and a depreciation of the real exchange rate.
D)a surge in net capital inflows and rising inflation.

Question 76

The purpose of the Financial Services Oversight Council, which was created in the 2010 regulatory reforms, is to:

A)replace the existing regulatory agencies with one agency to enforce all financial regulation.
B)focus on regulating previously unregulated financial institutions.
C)determine appropriate levels of executive compensation for the financial industry.
D)coordinate regulation and watch for dangers in the entire financial system.

Question 77

The key difference between financial crises in emerging markets and those in industrialized countries is that emerging markets experience:

A)capital flight.
B)an asset-bubble collapse.
C)a liquidity crisis.
D)a credit crunch.

Question 78

All of the following are proposals designed to discourage excessive risk-taking except:

A)increasing deposit insurance coverage.
B)requiring "skin in the game."
C)altering the pay and incentive structure for rating agencies.
D)reforming executive compensation.

Question 79

In emerging economies, capital flight can be triggered by:

A)rising government debt.
B)political risk.
C)banking problems.
D)All of the Answer s are correct.

Question 80

Capital flight that spreads from one country to another is a process called:

A)depreciation.
B)intermediation.
C)contagion.
D)appreciation.