Deck 8: Why Do Financial Crises Occur and Why Are They so Damaging to the Economy

Question 1

In an emerging market economy, there are typically two paths to a financial crisis: financial liberalization/globalization and ________.

A)asset pricing bubbles
B)severe fiscal imbalances
C)a global financial crisis
D)none of the above

Answer 1

severe fiscal imbalances

Question 2

When asset prices fall following a boom,

A)moral hazard may increase in companies that have lost net worth in the bust.
B)financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging.
C)both A and B are correct.
D)none of the above are correct.

Answer 2

both A and B are correct.

Question 3

What is a credit boom?

A)an explosion in a credit cycle, which can increase or decrease lending in the short-run
B)essentially a lending spree on the part of banks and other financial institutions
C)when credit card receivables rise due to low initial interest rates
D)the signal of the end of a credit spree, with credit contracting rapidly

Answer 3

essentially a lending spree on the part of banks and other financial institutions

Question 4

Stage Two of a financial crisis in an emerging market economy usually involves a ________ crisis.

A)currency
B)stock market
C)banking
D)commodities

Question 5

Stage Three of a financial crisis in an advanced economy features

A)a general increase in inflation.
B)debt deflation.
C)an increase in general price levels.
D)a full-fledged financial crisis.

Question 6

During the 1800s, many U.S. financial crises were precipitated by an increase in ________, often originating in London.

A)interest rates
B)housing prices
C)gasoline prices
D)heating oil prices

Question 7

Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.

A)currency
B)stock market
C)banking
D)commodities

Question 8

Financial crises

A)cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers.
B)are a recent phenomenon that occur only in developing countries.
C)invariably lead to debt deflation.
D)all of the above.
E)none of the above.

Question 9

In Stage Two of an financial crisis in an emerging economy, speculators engage in massive ________ of a currency if it is fixed against the U.S. dollar.

A)sales
B)purchases
C)either A or B can be correct
D)neither A nor B is correct

Question 10

The process of deleveraging refers to

A)cutbacks in lending by financial institutions.
B)a reduction in debt owed by banks.
C)both A and B.
D)none of the above.

Question 11

In an emerging market economy, a financial crisis generally begins with

A)mismanagement of financial liberalization or innovation.
B)asset pricing booms and busts.
C)an increase in uncertainty caused by failure of financial institutions.
D)all of the above.

Question 12

Factors that lead to worsening conditions in financial markets include

A)declining interest rates.
B)anticipated increases in the price level.
C)bank panics.
D)only A and C of the above.
E)only B and C of the above.

Question 13

What does the "twin crises" in an emerging market financial crisis refer to?

A)both the currency crisis and the financial crisis
B)both the fiscal crisis and the banking crisis
C)both the inflation crisis and the asset bubble crisis
D)both the fiscal crisis and political crisis

Question 14

In an advanced economy, a financial crisis can begin in several ways, including:

A)mismanagement of financial liberalization or innovation.
B)asset pricing booms and busts.
C)an increase in uncertainty caused by failure of financial institutions.
D)all of the above.

Question 15

Stage Three of a financial crisis in an emerging market economy features

A)a general increase in inflation.
B)debt deflation.
C)an increase in general price levels.
D)a full-fledged financial crisis.

Question 16

Factors that lead to worsening conditions in financial markets include

A)increases in interest rates.
B)declining stock prices.
C)increasing uncertainty in financial markets.
D)all of the above.
E)only A and B of the above.

Question 17

In an emerging market economy, a country typically faces a ________ fiscal policy before a crisis initiates.

A)solid
B)poor
C)weakening
D)uncertain

Question 18

In an emerging market economy, bank regulators typically provide ________ supervision.

A)overbearing
B)adequate
C)weak
D)expert

Question 19

Financial crises

A)are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.
B)occur when adverse selection and moral hazard problems in financial markets become more significant.
C)frequently lead to sharp contractions in economic activity.
D)are all of the above.
E)are only A and B of the above.

Question 20

Debt deflation refers to

A)an increase in net worth, leading to a relative fall in general debt levels.
B)a decline in general debt levels due to deleveraging.
C)a decline in bond prices as default rates rise.
D)a decline in net worth as price levels fall while debt burden remains unchanged.

Question 21

During a bank panic, many banks fail in a very short time period.

Question 22

Approximately how large was the U.S. subprime mortgage market in 2007?

A)$100 million
B)$100 billion
C)$500 billion
D)$1 trillion

Question 23

Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as

A)stock prices declined to 10 percent of their levels in 1929.
B)banks failed.
C)the aggregate price level declined.
D)a result of all of the above.
E)a result of A and B of the above.

Question 24

Which of the following factors led up to the Mexican financial crisis of 1994?

A)speculative attacks on the peso and a rise in actual and expected inflation
B)a rise in domestic interest rates and a deterioration in bank balance sheets
C)a rise in foreign interest rates and domestic stock market declines
D)all of the above
E)only B and C of the above

Question 25

When we refer to the shadow banking system, what are we talking about?

A)hedge funds, investment banks, and other nonbank financial firms that supply liquidity
B)the "underground" banking system used for illegal activities
C)the subsidiaries of depository institutions
D)none of the above

Question 26

The Internet stock market bubble of the late 1990s led to one of the worst financial crises in U.S. history. Banks lost billions of dollars as Internet companies went bankrupt.

Question 27

Bank failures have been a feature of all U.S. financial crises from 1800 to 1944.

Question 28

Prior to the financial crisis in Mexico in 1994, Mexico ran a budget deficit of around ________ of GDP.

A)120%
B)40%
C)15%
D)1%

Question 29

Which of the following led to the U.S. financial crisis of 2007-2009?

A)financial innovation in mortgage markets
B)agency problems in mortgage markets
C)an increase in moral hazard at credit rating agencies
D)all of the above
E)only A and B of the above

Question 30

Argentina's 2001-2002 financial crisis was precipitated by

A)a weak and poorly supervised banking system.
B)a lending boom that fueled a stock market bubble.
C)difficulty financing a large budget deficit.
D)a decline in interest rates.

Question 31

Institutional features of debt markets in Asia that propelled several countries into financial crises include

A)debt contracts with long durations.
B)firms with debt denominated in U.S. dollars.
C)governments that could not intervene to protect depositors.
D)all of the above.
E)only A and C of the above.

Question 32

In an emerging market economy, a country often faces severe fiscal imbalances before a financial crisis initiates.

Question 33

In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by ________ firms' and households' interest payments, thereby ________ their cash flow.

A)increasing; increasing
B)increasing; decreasing
C)decreasing; increasing
D)decreasing; decreasing

Question 34

The failure of Ohio Life Insurance and Trust in 1857 did not signal the start of a recession due to prompt actions by the Fed.

Question 35

Debt deflation refers to the decline in debt values as creditors agree to lower interest rates as an alternative to defaults.

Question 36

The impact of the 2007-2009 financial crisis was widespread, including

A)the first major bank failure in the UK in over 100 years.
B)the failure of Bear Stearns, the fifth-largest U.S. investment bank.
C)the bailout of Fannie Mae and Freddie Mac by the U.S. Treasury.
D)all of the above.
E)only B and C of the above.

Question 37

What is a credit default swap?

A)a swap agreement where two parties swap credit payments
B)an agreement to swap interest payments when one party defaults
C)a type of insurance against bond defaults
D)a swap between credit rating agencies

Question 38

Factors that can lead to worsening conditions in financial markets include increasing interest rates and asset price booms.

Question 39

Most financial crises in the United States have begun with

A)a steep stock market decline.
B)an increase in uncertainty resulting from the failure of a major firm.
C)a steep decline in interest rates.
D)all of the above.
E)only A and B of the above.

Question 40

Stock market declines preceded a full-blown financial crisis

A)in the United States in 1987.
B)in the United States in 2000.
C)in Indonesia in 1997.
D)in all of the above.
E)in none of the above.

Question 41

Describe the sequence of events in a financial crisis in an emerging market economy and explain why they can cause economic activity to decline.

Question 42

Describe the sequence of events in a financial crisis in an advanced economy and explain why they can cause economic activity to decline.

Question 43

Contrast the stages of a financial crisis between an advanced economy and an emerging market economy.

Question 44

What does the "twin crises" in an emerging economy financial crisis refer to?

Question 45

In an emerging market economy, a lending boom and crash are not inevitable outcomes of financial liberalization and globalization. Discuss when a boom and crash will occur, and how it can be avoided.

Question 46

In the second stage of a financial crisis in an emerging economy, a speculative currency attack begins. Why can't the government defend itself from such an attack?

Question 47

Why was the shadow banking system important during the 2007-2009 U.S. financial crisis?

Question 48

In an emerging market economy, a lending boom and crash are inevitable outcomes of financial liberalization and globalization.

Question 49

Discuss why some view the Fed as a culprit in the U.S. housing bubble during the 2000s.

Question 50

In the second stage of a financial crisis in an emerging economy, foreign exchange markets start placing huge bets that there will be an appreciation of the emerging market country's currency.

Question 51

Because asset markets are relatively small in an emerging market, they play less of a prominent role in a financial crisis in those economies.

Question 52

Discuss the difference in Stage Two of a financial crisis between an advanced economy and an emerging market economy.

Question 53

Discuss some of the financial innovations in mortgage markets that led to the U.S. financial crisis in 2007.

Question 54

In an emerging market economy, the financial globalization process further weakens the credit culture by allowing domestic banks to borrow abroad.

Question 55

What is the problem with government safety nets, such as deposit insurance, during the formative stages of a financial crisis?