Question 1

Theoretically, during a ﬁnancial crisis, the Fed is supposed to act as a lender of last resort to

Accepted Answer

The Fed is supposed to act as a lender of last resort to solvent banks that are illiquid, meaning that they have temporary cash flow problems but their assets exceed their liabilities. The Fed is not supposed to bail out insolvent banks that have more liabilities than assets, as this would be seen as rewarding bad management and could create moral hazard. The Fed also does not necessarily need to step in to help insolvent banks that are already highly liquid, as they should not be facing liquidity problems in the first place.

Question 2

Which of the following is not true about subprime mortgage loans?

Accepted Answer

Subprime mortgage loans were not discouraged by the government and were even encouraged through policies like the Community Reinvestment Act. They were considered high-risk loans because the borrowers had poor credit ratings, and they played a central role in the financial crisis of 2007-2008.

Question 3

Economic studies suggest there is

Accepted Answer

Economic studies suggest that there is an inverse relationship between the degree of independence of the central bank and the size of the average annual rate of inflation. This means that as the central bank becomes more independent, it is better equipped to control inflation and keep it in check. On the other hand, when the central bank is less independent, it may face pressure from other branches of the government to adopt policies that are inflationary in nature. Therefore, countries with more independent central banks tend to have lower average annual rates of inflation compared to countries with less independent central banks.

Question 4

The government bailout of large institutions creates the problem of moral hazard, which means that these large ﬁrms will

Accepted Answer

The government bailout of large institutions creates moral hazard because these institutions know that they will be bailed out if they take highly risky investments and suffer losses. This creates an incentive for them to take on more risk than they otherwise would, knowing that the taxpayer will bear the cost of any losses.

Question 5

When a bank's loans are written off, then the bank's

Accepted Answer

When a bank's loans are written off, it means that the bank has deemed those loans as uncollectible and has removed them from its balance sheet. This results in a decrease in the bank's assets and an increase in its liabilities, which can restrict the bank's ability to make new loans as it has less available capital.

Question 6

The major wave of defaults on home mortgages in 2007 destabilized

Accepted Answer

The major wave of defaults on home mortgages in 2007 destabilized many banks, including those that made the loans indirectly. This led to a financial crisis that affected the entire banking system and had an impact on the global economy.

Question 7

When you use money to purchase groceries, money is functioning as a store of value.

Accepted Answer

When you use money to purchase groceries, money is functioning as a medium of exchange, not primarily as a store of value.

Question 8

The bailout money that went to giant ﬁnancial institutions like Citibank and Goldman Sachs, along with General Motors and Chrysler, during the ﬁnancial crisis and the Great Recession, came from the

Accepted Answer

The Troubled Assets Relief Program (TARP) was a program created by the US government in 2008 to purchase assets and equity from financial institutions in order to strengthen the financial sector during the financial crisis. Many major financial institutions, such as Citibank and Goldman Sachs, received funds from TARP, as did the automobile manufacturers General Motors and Chrysler. The American Recovery and Reinvestment Act did provide stimulus funds to help boost the economy during the recession, but this did not go directly to these specific institutions. The Primary Dealer Credit Facility and the Term Securities Lending Facility were both programs created by the Federal Reserve to provide short-term loans to banks and financial institutions, but these were not part of the TARP program.

Question 9

If a ﬁrm possesses assets whose value exceeds the value of its debts, the ﬁrm is said to be

Accepted Answer

If the value of a firm's assets exceeds the value of its debts, then the firm is considered solvent. Insolvent means the opposite, where the value of debts exceeds the value of assets, and illiquid means the firm does not have enough cash or assets that can be quickly converted to cash to cover its short-term obligations. Liquid means a firm has enough cash or assets that can be quickly converted to cash to cover its short-term obligations.

Question 10

During the Financial Crisis of 2007-2008, Goldman Sachs, Morgan Stanley, and other ﬁnancial ﬁrms with heavy exposure to the mortgage-related problems rushed to become bank holding companies in order to

Accepted Answer

By becoming bank holding companies, these financial firms gained access to the Federal Reserve's discount window, allowing them to borrow money directly from the Fed to address their liquidity needs during the crisis.

Question 11

In practice, during a ﬁnancial crisis, the Fed and other central banks are under pressure to adopt an "extend and pretend" policy, in order to contain the wave bankruptcies. "Extend and pretend" refers to extending loans

Accepted Answer

"Extend and pretend" refers to extending loans to both solvent and insolvent financial firms, as long as they could pledge enough assets. This policy is designed to contain the wave of bankruptcies by keeping the financial firms afloat and giving them time to restructure and rebuild their balance sheets. However, this policy also comes with risks, as it can lead to moral hazard and encourage risky behavior in the future.

Question 12

The Bureau of Consumer Financial Protection was created in 2010 to become part of the

Accepted Answer

The Bureau of Consumer Financial Protection (also known as the Consumer Financial Protection Bureau or CFPB) was created as an independent agency within the Federal Reserve System through the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It is not part of the U.S. Treasury Department, Department of Commerce, or Office of the President.

Question 13

During a ﬁnancial crisis, the Fed and other central banks often adopt an "extend and pretend" policy in their emergency lending activities. Which of the following is not a consequence of this policy?

Accepted Answer

The "extend and pretend" policy may have consequences such as limiting the potential for insolvent banks to drag down the solvent ones, enhancing moral hazard, and allowing poorly managed firms to avoid bankruptcy. However, it does not increase the chances of the Fed or another central bank being dragged into its own bankruptcy crisis. This is because central banks have the ability to create money and manipulate the money supply to avoid insolvency.

Question 14

Which of the following is not true about so-called mortgage-backed securities?

Accepted Answer

The statement "Their use was strongly discouraged by the Federal government" is not true. In fact, the government played a role in promoting the use of mortgage-backed securities as a means of increasing home ownership.

Question 15

The Financial Crisis of 2007-2008 started in which sector of the economy?

Accepted Answer

The Financial Crisis of 2007-2008 started in the real estate and housing sector, specifically, the subprime mortgage market. The widespread issuance of subprime mortgages, where borrowers with low credit scores were given home loans with adjustable interest rates, led to a housing bubble that burst and triggered the financial crisis.

Question 16

Which of the following is not one of the causes of the skyrocketing mortgage default rates that triggered the ﬁnancial crisis in 2007-2008?

Accepted Answer

Mortgage default rates were triggered by a combination of lax lending practices, people taking on mortgages they couldn't afford to repay, and declining real estate values. However, the drastic increase in housing prices (choice C) was actually one of the factors that contributed to the housing bubble, which eventually led to the crisis.

Question 17

The reason for the Fed being set up as an independent agency of government is to

Accepted Answer

The reason for the Fed being set up as an independent agency of government is to protect it from political pressure. This is because monetary policy decisions should be based on economic considerations rather than political considerations. Therefore, the Fed is designed to be an independent agency that is not subject to political influence or control, which allows it to make decisions that are in the best interest of the economy.

Question 18

The so-called moral hazard problem refers to one's tendency to

Accepted Answer

The moral hazard problem refers to the increase in risk-taking behavior that occurs when individuals or institutions are insured against losses. This is because they are less likely to bear the full cost of their actions if things go wrong, and so are more willing to take on risky behavior.

Question 19

The destabilizing effects of defaulting mortgages quickly spread throughout the ﬁnancial system because those mortgages were involved in widespread

Accepted Answer

Securitization refers to the practice of bundling mortgages into securities and selling them to investors. This process allowed the defaulting mortgages to spread their destabilizing effects through the financial system, as investors who had purchased these securities suffered losses.

Question 20

"Thrifts" refers to the following institutions except

Accepted Answer

Thrifts include credit unions, mutual savings banks, and savings and loan associations. They do not include commercial banks, which operate under a different regulatory framework.

Quiz 14: Money, Banking, and Financial Institutions