Deck 8: Subprime Lending Fiasco Ethics Issues.

Question 1

Investors relied on the judgment of credit rating agencies because

A) credit rating agencies are supposed to be the experts in evaluating credit risk.
B) information directly available to investors on mortgage pools was insufficient.
C) credit rating agencies are supposed to perform a thorough due diligence before rating a given security.
D) credit rating agencies are supposed to be the experts in evaluating credit risk, and they are supposed to perform a thorough due diligence before rating a given security.
E) All of these are correct.

Answer 1

All of these are correct.

Question 2

Which of these regulators were aware of the problem and tried to blow the whistle in 2003?

A) Security and Exchange Commission and Federal Reserve Board
B) Iowa and North Carolina State Attorneys
C) Office of the Comptroller of the Currency and Office of Thrift Supervision
D) federal banking regulators
E) None of these are correct.

Answer 2

Iowa and North Carolina State Attorneys

Question 3

Which entities worked as second party consolidators, purchasing loans and reselling them to investors?

A) Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac)
B) structured investment vehicles (SIVs)
C) credit rating agencies
D) investment banks
E) All of these are correct.

Answer 3

Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac)

Question 4

According to former Federal Reserve Chairman Alan Greenspan, the Fed became concerned about subprime lending in 2000; however,

A) the global demand for mortgage-backed security ended in 2005.
B) the quality of mortgage products began to deteriorate in 2005.
C) the global demand for mortgage-backed security started in 2003.
D) the quality of mortgage products began to deteriorate in 2003.
E) the global demand for mortgage-backed security ended in 2008.

Question 5

Some observers claim that the U.S. Federal Reserve Board encouraged the housing and credit bubbles by

A) not regulating subprime mortgages.
B) cutting interest rates.
C) enforcing mark to market accounting.
D) not regulating subprime mortgages and cutting interest rates.
E) not regulating subprime mortgages and enforcing mark to market accounting.

Question 6

Rating agencies were exposed to a conflict of interest because

A) credit rating agencies were rating securities and investing in those securities.
B) credit rating agencies used ratings to sell securities.
C) clients of the credit rating agencies used ratings to sell securities.
D) investors do not want rating downgrades.
E) credit rating agencies were paid by the firms who created the securities being rated.

Question 7

In simple terms, the securitization process is

A) a way to sell structured investment vehicles (SIVs).
B) a way to sell accounts receivable by mortgage lenders to public investors.
C) a way to create high-yield investments with little risk.
D) a way to sell structured investment vehicles (SIVs), and a way to create high-yield investments with little risk.
E) All of these are correct.

Question 8

Goldman Sachs' GSAMP Trust was able to create AAA rated securities by

A) separating the mortgage portfolio into tranches and assigning the tranches to share risks of default equally.
B) not disclosing the risks clearly.
C) guaranteeing or protecting some tranches.
D) separating the mortgage portfolio into tranches and designating the A-1, A-2, and A-3 tranches last in order, after the M-1 to M-7 and B-1 to B-3 tranches, to suffer losses if a default occurred.
E) All of these are correct.

Question 9

Early in 2008, mark-to-market accounting provisions caused the banks to

A) revalue their portfolio downwards.
B) be in jeopardy of falling below the regulatory capital requirements.
C) restrict new loans.
D) revalue their portfolio downwards, and restrict new loans.
E) All of these are correct.

Question 10

The 1999 Gramm-Leach-Bliley Act allowed banks to

A) engage in subprime lending.
B) sell insurance.
C) become more involved in investment bank activities.
D) underwrite government bonds.
E) choose between commercial and investment bank activities.

Question 11

Mark-to-market accounting is usually related to all of the following items, EXCEPT

A) derivatives and financial instruments.
B) firm's long term cash flows.
C) firm's short term taxes payable.
D) firm's short term cash flows.
E) immediate recognition of unrealized gains and losses.

Question 12

A fundamental problem with Goldman Sachs' GSAMP Trust was that

A) loans were given to people with poor credit histories.
B) homeowners' equity in the securitized mortgages was less than 1 percent on average.
C) loans were given to people with no income.
D) a sizeable portion of the securitized loans had little or no documentation.
E) All of these are correct.

Question 13

Mortgage-backed securities lost their value when

A) the underlying assets lost their value.
B) borrowers (the mortgagees) walked away without real obligation to repay.
C) mortgage originators went bankrupt.
D) the underlying assets lost their value, and borrowers (the mortgagees) walked away without real obligation to repay.
E) mortgage originators went bankrupt, and borrowers (the mortgagees) walked away without real obligation to repay.

Question 14

In simple terms, a mortgage-backed security is

A) a portfolio of mortgages sold to investors through publicly issued bonds.
B) a contract that transfers ownership of a lender's mortgages receivable.
C) a contract that transfers the risk of non-collection from mortgage originators to other investors.
D) a portfolio of mortgages sold to investors through publicly issued bonds, and a contract that transfers the risk of non-collection from mortgage originators to other investors.
E) All of these are correct.

Question 15

Mark-to-market accounting is incorrectly characterized as

A) relevant for management compensation purposes.
B) relevant for valuation purposes.
C) relevant to investors.
D) sometimes misleading.
E) responsible for the subprime lending fiasco.

Question 16

The movie The Big Short is the story of a few clever investors who realized that security markets were about to crash, and they

A) invested in CDOs.
B) invested in CDSs.
C) invested in NCDSs.
D) sold stocks short.
E) bought gold.

Question 17

The 1933 Glass-Steagall Act precluded banks from

A) subprime lending.
B) selling insurance.
C) underwriting insurance generating more than 10% of total banking income.
D) underwriting securities generating more than 10% of total banking income.
E) underwriting any securities.

Question 18

Which of the following is NOT an example of aggressive lending practices contributing to the subprime crisis?

A) Mortgagors were not required to make any down payment at the inception of the loan.
B) Loans were given to people with poor credit histories.
C) Loans were given to people with no income.
D) A borrower could get a second mortgage and use it as down-payment.
E) None of these are correct.

Question 19

Late in 2008, the International Accounting Standards Board allowed firms to

A) reclassify devaluated financial assets delaying recognition of losses.
B) estimate the value of the portfolio if there is no ready market for a derivative portfolio.
C) reduce their capital requirements.
D) accelerate the recognition of losses through mark-to-market accounting
E) None of these are correct.

Question 20

An issue with mark-to-market accounting when there is a highly depressed market is that

A) depressed values could be only temporary, portfolios are likely to re-gain value, and thus current unrealized losses are overstated.
B) depressed values could be not only temporary, portfolios are likely to re-gain value, and thus current losses are overstated.
C) depressed values could be only temporary, portfolios are not likely to re-gain value, and thus current losses are understated.
D) depressed values could be only temporary, portfolios are not likely to re-gain value, and thus current non-realized gains are overstated.
E) depressed values could be only temporary, portfolios are likely to re-gain value, and thus current non-realized losses are understated.