Question 1

In October 2008, Congress passed the ________, under which the Treasury provided funds to banks in exchange for stock.

Accepted Answer

The Troubled Asset Relief Program (TARP) was passed in October 2008 by Congress, under which the Treasury provided funds to banks in exchange for stock. The other options, Bank Rescue Alliance Treaty (BRAT), Mortgage Transfer Agency (MTA), and Financial Assurance Association (FAA), are not actual programs or legislation related to the 2008 financial crisis.

Question 2

Firms that participate in regular open market transactions with the Federal Reserve are called

Accepted Answer

Firms that participate in regular open market transactions with the Federal Reserve are called primary dealers.

Question 3

By the 2000s, an important market change occurred when investment banks became significant participants in the secondary market for

Accepted Answer

By the 2000s, investment banks had become significant participants in the secondary market for mortgages, particularly through the securitization of mortgage-backed securities. This played a key role in the financial dynamics leading up to the 2008 financial crisis.

Question 4

Although the Federal Reserve had traditionally made discount loans only to commercial banks, in response to the financial crisis in 2008 the Fed made ________ eligible for discount loans as well.

Accepted Answer

During the financial crisis in 2008, the Federal Reserve expanded its emergency lending to include not just commercial banks but also primary dealers, which are firms authorized to trade directly with the Fed. This move was intended to provide more liquidity to the financial system and help stabilize the markets. The other options (Treasury Department, mortgage brokers, and savings banks) were not made eligible for discount loans during this time.

Question 5

By the height of the housing bubble in 2005 and early 2006, lenders had greatly loosened the standards for obtaining a mortgage loan, with many mortgages being granted to sub-prime borrowers ________ and "Alt-A" borrowers ________.

Accepted Answer

Sub-prime borrowers have flawed credit histories, while "Alt-A" borrowers do not document their incomes. Therefore, the best choice for the first blank is A, and for the second blank, the best choice is also A.

Question 6

By the height of the housing bubble in 2005 and early 2006, lenders had greatly loosened the standards for obtaining a mortgage loan, with many mortgages being granted to ________ borrowers with flawed credit histories and ________ borrowers who did not document their incomes.

Accepted Answer

The passage mentions "sub-prime borrowers with flawed credit histories" and "borrowers who did not document their incomes," which are both characteristics of loans granted to sub-prime borrowers. "Alt-A" is also mentioned as a type of borrower who did not document their income. Thus, choice A is the best answer. Choices B, C, and D are not mentioned in the passage at all, making them incorrect.

Question 7

The Federal Reserve responded to the 2008 financial crisis in several ways. Which of the following is one of the ways the Fed responded?

Accepted Answer

The Fed engaged in a process called quantitative easing, where it lent investment banks Treasury securities in exchange for mortgage-backed securities. This was done to increase the liquidity of the banks and stimulate lending. Option A is incorrect as investment banks were allowed to obtain discount loans. Option C is partially correct, as the Fed did lower the required reserve ratio, but it was on all types of deposits, not just demand deposits. Option D is incorrect as the Fed did not help Citibank acquire General Motors or Chrysler.

Question 8

A financial asset is considered ________ if it can be sold in a secondary market.

Accepted Answer

A security is a financial asset that can be bought or sold in a secondary market. This includes stocks, bonds, and options, among others. Commodity refers to physical goods (e.g. oil, gold), liability refers to an obligation to pay (e.g. debt), and durable refers to a physical asset that is long-lasting (e.g. a car).

Question 9

In 2008, the Treasury and Federal Reserve took action to save large financial firms such as Bear Stearns and AIG from failing. Which of the following is one reason why these measures were taken?

Accepted Answer

The bankruptcy of a large financial firm would force the firm to sell its holdings of securities, which could cause other firms that hold these securities to also fail. This is known as a contagion effect and was a major concern during the financial crisis in 2008. By bailing out firms like Bear Stearns and AIG, the Treasury and Federal Reserve hoped to prevent a domino effect of failures in the financial sector.

Question 10

Although the Federal Reserve had traditionally made discount loans only to ________, in response to the financial crisis in 2008 the Fed made primary dealers eligible for discount loans as well.

Accepted Answer

The Federal Reserve traditionally made discount loans primarily to commercial banks. In response to the financial crisis in 2008, it expanded eligibility to include primary dealers, which are not limited to commercial banks but can include other financial institutions.

Question 11

While many analysts defended the actions taken by the Fed and the Treasury to respond to the financial crisis in 2008, others were critical of these actions. The critics were concerned that by not allowing large firms to fail,

Accepted Answer

Critics argued that rescuing large firms sets a precedent, encouraging other firms to take on excessive risk with the expectation of government bailouts, a concept known as "moral hazard."

Question 12

To reassure investors who were unwilling to buy mortgages in the secondary market, the U.S. Congress used two government sponsored enterprises, ________, to sell bonds to investors and use the funds to purchase mortgages from banks.

Accepted Answer

Fannie Mae and Freddie Mac were the two government-sponsored enterprises created by the U.S. Congress to buy mortgages from banks and sell them to investors in the secondary market. This helped to reassure investors who were unwilling to buy mortgages directly from banks. Options A, C, and D are not correct as they are not relevant to the government's efforts to stabilize the mortgage market.

Question 13

When housing prices ________, as they did beginning in 2006 following the housing market bubble, consumption spending on furniture, appliances, and home improvements declined as many households found it ________ to borrow against the value of their homes.

Accepted Answer

When housing prices fall, it becomes harder for households to borrow against the value of their homes.

Question 14

If the amount you owe on your house is greater than the price of the house, you have

Accepted Answer

When the amount owed on a house is greater than its price, it is known as negative equity or being "underwater" on the mortgage. This means that the value of the property has decreased and the borrower owes more than the property is worth. It does not necessarily indicate that the mortgage rate is too high or that a reverse mortgage has been taken out.

Question 15

The larger the fraction of an investment financed by borrowing,

Accepted Answer

Financing a larger portion of an investment with borrowing (leverage) amplifies both potential returns and potential losses because the investor is using borrowed funds to increase the size of the investment, which magnifies outcomes in both directions.

Question 16

When housing prices ________ as they did beginning in 2006 following the housing market bubble, most banks and other lenders tightened the requirement for borrowers, making it ________ for potential home buyers to obtain mortgages.

Accepted Answer

When housing prices fell, it became harder for potential home buyers to obtain mortgages as banks and other lenders tightened the requirement for borrowers.

Question 17

Firms that participate in regular open market transactions with ________ are called primary dealers.

Accepted Answer

Primary dealers are firms that participate in regular open market transactions with the Federal Reserve.

Question 18

The Federal Reserve responded to the 2008 financial crisis in several ways. Which of the following is not one of the ways the Fed responded?

Accepted Answer

The Fed did not lower the required reserve ratio on demand deposit accounts in response to the 2008 financial crisis. Instead, they implemented policies such as making investment banks eligible for discount loans, lending Treasury securities to investment banks in exchange for mortgage-backed securities, and helping JP Morgan acquire Bear Stearns. Lowering the required reserve ratio would have been a tool to increase bank liquidity, but this was not part of the Fed's response to the crisis.

Question 19

Prior to 1970, mortgages were ________ resold in the secondary market.

Accepted Answer

Prior to 1970, mortgages were rarely resold in the secondary market. The secondary mortgage market was not well-developed, and it was difficult to find buyers for these kinds of assets. Lenders would typically hold onto mortgages until they were paid off, and only in rare cases would they sell them to other institutions.

Question 20

Between September 2007 and March 2008 there was a substantial reduction in the demand for housing. What action did the Fed take in response to the reduction in the demand for housing?

Accepted Answer

The Federal Reserve cut the federal funds rate seven times in response to the reduction in the demand for housing. This was done in an effort to stimulate economic activity and encourage borrowing and spending. The other options (A, B, and D) are not directly related to addressing the reduction in housing demand. Decreasing the required reserve rate (A) would increase the amount of money banks have available to lend, but it would not necessarily address the issue of reduced housing demand. Open market sales of Treasury securities (B) could be used to decrease the money supply and raise interest rates, but this would be counterproductive if the goal is to increase borrowing and spending. Raising the discount rate (D) would make borrowing more expensive, which would also be counterproductive to the goal of stimulating economic activity.

Quiz 26: Monetary Policy