Deck 4: The Financial Crisis and Its Impact on the Mortgage Market and Economy

Question 1

The great credit crisis of 2007-2009 is the worst financial crisis since the Great Depression.

Answer 1

True

Question 2

The S&P 500 stock index reached an all time high of 1565.15 on March 9, 2009.

Answer 2

False

Question 3

Within only 19 months, the S&P 500 lost 57% of its value.

Answer 3

True

Question 4

The housing market was one of the only markets that survived the great credit crisis of 2007-2009 with minimal loss of value.

Question 5

The two most important assets for a household are its bank deposit account and its home.

Question 6

The two most important assets for a household are its home and its stock portfolios (either directly invested or indirectly invested through mutual funds).

Question 7

Prior to the great credit crisis, home prices in the U.S. were gradually falling by a rate of close to 2 percent per year.

Question 8

Between March 2007 and December 2008 many houses lost approximately 26 percent of their value.

Question 9

The term "underwater" means that owner owes more on their mortgage than they would like to.

Question 10

The term "underwater" means that the owner owes more on his or her mortgage than the house is worth.

Question 11

One of the most important contributions of the financial markets is to make possible the exchange of current income for future income.

Question 12

Seeing as how a household's home and stock portfolio are substantial assets, when they lose value the household is made worse off financially.

Question 13

Being that corporations and the government are so large, consumption spending amounts to only a tiny fraction of the U.S. GDP.

Question 14

GDP stands for Gross Domestic Product.

Question 15

Consumption purchases of households account for about two-thirds of U.S. GDP.

Question 16

The principal factor determining how much a household purchases is the quality and availability of products.

Question 17

The principal factor determining how much a household purchases is its net worth.

Question 18

Net worth is defined as one's monthly income less one's monthly expenses.

Question 19

Net worth is defined as the total value of one's assets less the total value of one's liabilities.

Question 20

From September 2007 through December 2008, the collective net worth of U.S. households rose by nearly $1 trillion.

Question 21

From September 2007 through December 2008, the collective net worth of U.S households fell by nearly $13 trillion.

Question 22

When the collective net worth of U.S. households experienced a 20 percent loss, three-quarters of the loss was due to the collapse in the housing market and the decline in the stock market.

Question 23

The interconnection between the stock market, home prices, a household's net worth, consumption spending, and the aggregate economy helped lead to the great credit crisis of 2007-2009.

Question 24

A large drop in wealth can lead to a reduction in consumer confidence and spending.

Question 25

In December 2006, the U.S. economy entered into an ever-deepening recession.

Question 26

By April 2009 unemployment reached a record level of just over 12 percent.

Question 27

During the decades leading up to the great credit crisis, financial innovation was occurring rapidly.

Question 28

During the period leading up to the great credit crisis, strict regulations were in place within the financial market.

Question 29

Financial derivatives are a relatively new financial asset that developed within strictly regulated and monitored markets.

Question 30

Improper use of financial derivatives may perpetuate systemic risk.

Question 31

Interest income earned on bank loans is used to pay the bank's operating expenses as well as the interest it owes to its depositors and bondholders.

Question 32

When borrowers default, banks are not negatively affected, due to FDIC insurance.

Question 33

When a borrow defaults, the bank must write off the loan and absorb the loss by reducing its retained earnings.

Question 34

Capital requirements are set in place to help ensure that a bank has a cushion available in case many borrowers default simultaneously.

Question 35

A traditional mortgage is normally made for 15 years.

Question 36

A traditional mortgage normally requires a down payment of 30 percent.

Question 37

Subprime mortgages are typically geared toward borrowers with poor credit histories and/or inadequate asset holdings.

Question 38

Subprime mortgages typically carry lower interest rates than traditional mortgages.

Question 39

According to the textbook, both traditional and subprime mortgage default rates were shown to be pro-cyclical.

Question 40

According to the textbook, both subprime and traditional mortgages were shown to be counter-cyclical.

Question 41

According to the textbook, changes in the aggregate economy were shown to impact subprime mortgage default rates more severely than traditional mortgage default rates.

Question 42

Fannie Mae, Ginnie Mae, and Freddie Mac were all set up by the U.S. government to help create a nationwide market for home mortgages.

Question 43

The process of pooling assets together and selling bonds off of their joint income streams is a process known as securitization.

Question 44

Once assets have been securitized, they can no longer lose value.

Question 45

Through mortgage-backed securities, banks can remove the risky mortgages from their balance sheets as well as raise some funds from the sale of the pool of mortgages to the special purpose vehicle.

Question 46

The purchaser of mortgage-backed securities also receives the servicing rights to the underlying mortgages.

Question 47

From 1997 to 2007 the volume of new issues of MBSs increased tenfold.

Question 48

The biggest difference between mortgage-backed securities and collateralized mortgage obligations is that investors interested in mortgage-backed securities have a variety of risk tranches to choose from, while there are no such tranches provided by collateralized mortgage obligations.

Question 49

Investors in the highest priority tranche of a CMO must receive their return before the investors of any other tranche.

Question 50

A collateralized portfolio may consist of a pool of the lowest priority equity tranches of many CMOs.

Question 51

A collateralized debt obligation built solely on "junk" mortgages can still have a highest priority tranche that carries the highest quality rating available.

Question 52

CDOs are one example of the financial derivatives known as asset-backed securities (ABSs).

Question 53

The only financial asset that can be used in a CDO is a home mortgage.

Question 54

A credit default swap is a purely speculative asset.

Question 55

A naked credit default swap is a purely speculative asset.

Question 56

By 2007 there was over $62 trillion in credit instruments covered by credit default swaps worldwide.

Question 57

Commercial banks are regulated by the SEC.

Question 58

Investment banks are regulated by the SEC.

Question 59

Investment banks and commercial banks differ only in the type of client they serve.

Question 60

A bank's leverage ratio is the ratio of its loans and investments to its capital reserves.

Question 61

Commercial banks are to keep their leverage ratio at roughly 15 to 1.

Question 62

Investment banks are allowed to borrow at the Federal Reserve's discount window.

Question 63

Bear Stearns was purchased by Bank of America.

Question 64

TARP stands for the Troubled Asset Retirement Program.

Question 65

When Lehman Brothers started to publicly experience trouble the mortgage market was in ruins, and its balance sheet was in such terrible shape that it could not attract a potential buyer.

Question 66

Merrill Lynch was purchased by Bank of America.

Question 67

Both Morgan Stanley and Goldman Sachs changed into commercial banks during the credit crisis.

Question 68

According to the textbook, the most damaging to AIG's balance sheet was its exposure to MBSs.

Question 69

AIG was acquired by Morgan Stanley.

Question 70

The term too big to fail is used to refer to a firm that has grown so large and strong that it could weather any economic problem.

Question 71

The government completely took over control of AIG in order to prevent its failure during the credit crisis.

Question 72

The Federal Reserve's attempt to bail out AIG was completely successful, and AIG has repaid all of its debts to the U.S. government.

Question 73

An important task for regulators going forward is for them to ensure that financial innovation is closely monitored and occurs only after it receives approval from the government.

Question 74

One of the fundamental principles of the Obama Plan was the need to identify potential sources of systemic risk before they manifest themselves in the markets.

Question 75

The Financial Services Oversight Council would be put in place to oversee all things related to consumer protection in the financial services sector.

Question 76

Under the Obama Plan, the power of the Federal Reserve would be severely limited.

Question 77

The Obama Plan calls for the creation of a Consumer Financial Protection Agency that would have the authority to gather information from financial institutions as it sees fit to help protect consumers of financial services, as well as other powers.

Question 78

The great credit crisis of 2007-2009 represents the worst financial crisis in the U.S. since the:

A) 1960s
B) 1950s
C) 1940s
D) 1930s
E) None of the above

Question 79

On October 9, 2007 the S&P 500 stock index closed at an all time high of _______. 19 months later the index had fallen to _________, representing a substantial loss in consumer wealth.

A) 912.21; 101.91
B) 1798.88; 1210.33
C) 8988.23; 5121.32
D) 720.43; 232.87
E) 1565.15; 676.53

Question 80

Between March 2007 and December 2008 houses lost ______ percent of their value.

A) 50
B) 60
C) 35
D) 25
E) None of the above