Deck 30: The Financial Crisis and the Great Recession

Question 1

If a five-year Treasury bond pays an interest of 2.5 percent and a five-year corporate bond pays an interest rate of 4.5 percent, then the interest rate spread on the corporate bond equals 2 percent.

Answer 1

True

Question 2

It would be impossible to have an unlevered bank.

Answer 2

True

Question 3

An increase in the price of a particular bond implies an increase in the interest rate for that bond.

Answer 3

False

Question 4

Much of the TARP money was used to recapitalize banks.

Question 5

In 2008, interest rates on Treasury securities fell even though most other interest rates were rising.

Question 6

Both monetary policy and fiscal policy were used in response to the recession of 2007-2009.

Question 7

Borrowed funds are used in financing every component of GDP.

Question 8

In hindsight, mortgage-backed securities implied very limited risk because the underlying mortgages were spread across different geographic areas.

Question 9

The first signs of major financial problems associated with the financial sector and real estate investment appeared in 2009.

Question 10

Subprime mortgages were granted with low or negligible down payments to the borrowers of questionable credit standing who could barely afford their monthly payments.

Question 11

An asset price bubble occurs when the prices of some assets rise far above their fundamental values.

Question 12

Leverage is essential to a bank's profitability, but it also increases risk.

Question 13

In response to the economic downturn, the federal government enacted a fiscal stimulus bill with funding in excess of $700 billion.

Question 14

A home mortgage is a particular type of loan used to buy a house where the house serves as the collateral for the mortgage.

Question 15

An interest rate spread is the difference between an interest rate on a risky asset and the corresponding interest rate on a risk-free treasury security.

Question 16

A mortgage-backed security (MBS) is a type of bond whose interest payments and principal repayments derive from the monthly mortgage payments of many households.

Question 17

Spending on newly constructed homes is part of the investment component of GDP.

Question 18

The Federal Reserve helped J. P. Morgan purchase Bear Stearns by agreeing to purchase some unwanted Bear Stearns' assets.

Question 19

A company is insolvent when the value of its liabilities exceeds the value of its assets.

Question 20

Real economy took a sharp turn for the worse immediately after the bankruptcy filing by Lehman Brothers on September 15, 2008.

Question 21

Excessive leverage can be traced to lax regulation and inadequate laws.

Question 22

If the buyer commits $100,000 of his or her own funds and borrows $900,000 to purchase $1 million in assets, then the leverage ratio is

A) 10 to 1.
B) 25 to 1.
C) 9 to 1.
D) 5 to 1.

Question 23

The increased level of excess reserves that many banks held in 2008 made traditional monetary policy less effective.

Question 24

The central idea behind the Troubled Asset Relief Program was for the Treasury to sell mortgage-backed securities to interested investors, wait for prices to increase, and then buy these securities back for a profit.

Question 25

Assume that Michaela purchases $12,000 worth of a stock. To do so she uses $2,000 of her own money and borrows the remaining $10,000 at an 8.0 percent interest rate. If the stock's value increases by 20 percent in one year and she sells the stock at that time, what is her rate of return?

A) 13 percent
B) 16 percent
C) 20 percent
D) 80 percent

Question 26

Assume that Sharon purchases $5,000 worth of a stock. To do so she uses $1,000 of her own money and borrows the remaining $4,000 at a 7.0 percent interest rate. If the stock's value decreases by 10 percent in one year and she has to sell the stock at that time, what is her rate of return?

A) −10 percent
B) −50 percent
C) −78 percent
D) −156 percent

Question 27

Suppose that a five-year Treasury bond pays 2.5 percent and a five-year corporate bond pays 8.5 percent, then what is the interest rate spread on this particular corporate bond?

A) 5 percent
B) 6 percent
C) 7.5 percent
D) 9.0 percent

Question 28

Assuming that the reserve ratio is 10 percent, what amount of excess reserves are held by with the bank balance sheet listed below?

A) zero
B) $240,000
C) $280,000
D) $320,000

Question 29

The Fed's loan that effectively nationalized AIG was approved by Congress.

Question 30

When the housing bubble burst, prices fell particularly severely in

A) Georgia.
B) Nevada.
C) Pennsylvania.
D) West Virginia.

Question 31

A bubble is best defined as a(n)

A) increase in the price of an asset resulting from fundamental causes.
B) increase in the price of an asset resulting from factors other than fundamental causes.
C) decrease in the price of an asset resulting from fundamental causes.
D) decrease in the price of an asset resulting from factors other than fundamental causes.

Question 32

If a 10-year Treasury bond pays 3.1 percent and a 10-year corporate bond pays 7.4 percent, what is the interest rate spread on this particular corporate bond?

A) 4.3 percent
B) 7.4 percent
C) 10.5 percent
D) 22.9 percent

Question 33

Which of the following was not a typical characteristic of subprime mortgages?

A) Low down payments
B) Loans to borrowers with poor credit histories
C) Limited incomes with which to make loan payments
D) Fixed interest rates

Question 34

Most economists feel that overly strict financial regulation from 2000 to 2006 contributed to the financial crisis of 2007-2009.

Question 35

A bank is said to be recapitalized when some investor, private or government, provides new equity capital in return for partial ownership.

Question 36

A bank would be considered insolvent when the value of its liabilities exceed its

A) assets.
B) required reserves.
C) actual reserves.
D) net worth.

Question 37

The recession of 2007-2009 was the most severe economic downturn in the United States since the

A) 1930s.
B) 1950s.
C) 1970s.
D) 1980s.

Question 38

What is the leverage implied by the bank balance sheet listed below?

A) 2-to-1
B) 7-to-1
C) 8-to-1
D) 10-to-1

Question 39

If the reserve ratio was 10 percent for the bank with the balance sheet listed below, then this bank is being

A) aggressive as indicated by a small amount of excess reserves.
B) aggressive as indicated by a large amount of excess reserves.
C) cautious as indicated by a small amount of excess reserves.
D) cautious as indicated by a large amount of excess reserves.

Question 40

What is the leverage implied by the bank balance sheet listed below?

A) 10-to-1
B) 12-to-1
C) 20-to-1
D) 21-to-1

Question 41

Which of the following arguments is not a valid argument against the effectiveness of the fiscal stimulus bill?

A) Employment continued to fall into early 2010.
B) Without stimulus recessions come to an end naturally.
C) State and local government spending increased.
D) Monetary policy played a large role in stimulating the economy.

Question 42

The intended use of TARP funds was to

A) support the FDIC.
B) increase consumers' disposable income.
C) fund "shovel-ready" projects.
D) purchase unwanted securities.

Question 43

Which of the following elements of GDP were affected by the financial crisis and the lack of available credit?

A) Consumption and business investment only
B) Consumption and government spending only
C) Consumption, business investment, and government spending only
D) Consumption, business investment, government spending, and imports/exports

Question 44

The Lehman Brothers bankruptcy triggered a financial panic that featured a(n)

A) increase in Treasury interest rates and an increase in most other interest rates.
B) increase in Treasury interest rates and a decrease in most other interest rates.
C) decrease in Treasury interest rates and an increase in most other interest rates.
D) decrease in Treasury interest rates and a decrease in most other interest rates.

Question 45

The 2009 fiscal stimulus bill represented approximately

A) 5.5 percent of GDP and was designed to close the expansionary gap.
B) 5.5 percent of GDP and was designed to close the recessionary gap.
C) 7.8 percent of GDP and was designed to close the expansionary gap.
D) 7.8 percent of GDP and was designed to close the recessionary gap.

Question 46

As a result of the Great Recession, job growth did not resume until

A) September 2008.
B) March 2009.
C) September 2009.
D) March 2010.

Question 47

Mortgage-backed securities became a significant issue because I. housing prices fell across all regions. II. these securities were not as widely distributed as previously thought.

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 48

As a result of Lehman's collapse, real GDP first began to fall in

A) the fourth quarter of 2007.
B) the second quarter of 2008.
C) the third quarter of 2008.
D) the first quarter of 2009.

Question 49

In 2007, which of the following U.S. firms showed the first indication of significant problems in the financial sector?

A) AIG
B) Bear Stearns
C) J.P. Morgan Chase
D) Lehman Brothers

Question 50

What amount of money was appropriated by Congress for fiscal stimulus bill of 2009?

A) $225 billion
B) $252 billion
C) $700 billion
D) $787 billion

Question 51

In computing GDP, new home construction adds to

A) consumption.
B) investment.
C) government spending.
D) net exports.

Question 52

Which of the following was not a factor that contributed to the subprime mortgage crisis?

A) False security derived from FDIC insurance on mortgage loans
B) Lower down payments
C) Households devoting 25 percent or more of their income to mortgage payments
D) Lending to households with adverse credit ratings

Question 53

What amount of money was appropriated by Congress for the Troubled Asset Relief Program?

A) $225 billion
B) $252 billion
C) $700 billion
D) $787 billion

Question 54

The Federal Reserve stepped in to help

A) Bear Stearns but not Lehman Brothers.
B) Lehman Brothers but not Bear Stearns.
C) both Bear Stearns and Lehman Brothers.
D) neither Bear Stearns nor Lehman Brothers.

Question 55

As a result of the Great Recession, most financial markets hit bottom around

A) September 2008.
B) March 2009.
C) September 2009.
D) March 2010.

Question 56

Which of the following was not a lesson from the 2007-2009 financial crisis?

A) Financial regulations were too "light" prior to the crisis.
B) Excessive complexity made the financial system more fragile and dangerous.
C) Both monetary policy and fiscal policy are needed in order for the economy to recover.
D) Regulatory failures were based primarily on poor job performance.

Question 57

What was the lowest federal funds rate target the Fed set in response to the financial crisis?

A) 0 percent
B) 1.8 percent
C) 2.0 percent
D) 2.2 percent

Question 58

Which of the following was a lesson from the 2007-2009 financial crisis?

A) The financial system needed more leverage in order to operate.
B) The job of stabilizing the economy should be assigned exclusively to monetary policy.
C) Monetary policy is finished once the Fed reduces the federal funds rate to zero.
D) The business cycle still exists.

Question 59

In 2008, the Fed utilized expansionary monetary policy, which was made

A) more effective as banks held more excess reserves.
B) less effective as banks held more excess reserves.
C) more effective as banks held less excess reserves.
D) less effective as banks held less excess reserves.

Question 60

Which of the following are accurate arguments suggesting that the fiscal stimulus did work?

A) Real GDP growth moved from negative to positive in 2009.
B) Employment increased in 2009.
C) The economy has natural self-correcting mechanisms.
D) The return on bailout assets reduced the deficit.

Question 61

Name some important lessons learned from the financial crisis.

Question 62

Did President Obama's $787 billion fiscal stimulus package of early 2009 work? Name several facts in support of the proposition that it did. Also, list the arguments of the skeptics.

Question 63

Which of the following was not a lesson from the 2007-2009 financial crisis?

A) Regulatory failures were the result of weaknesses across the regulatory structure.
B) The financial system operated with too much leverage.
C) The business cycle no longer applies to economic analysis.
D) Monetary policy alone may not be sufficient to stabilize aggregate demand.

Question 64

Why did observers at first believe that the damage from the impending subprime mortgage crisis would be too small to cause a recession?

Question 65

Because the U.S. economy failed to snap back from a mild recession in 2001, the Fed pushed the federal funds rate down to 1 percent. What effect did this have on the economy?

Question 66

When the housing price bubble burst, there were some obvious effects on the economy, and some that were not so obvious. Explain these.