Deck 12: Financial Crises and Financial Regulation

Question 1

Which of the following is NOT true of an insolvent bank?

A) Its net worth is negative.
B) It may be unable to pay off its depositors.
C) The value of its assets is less than the value of its liabilities.
D) It must have no more deposits.

Answer 1

D

Question 2

By how much did real investment decline between 1929 and 1933?

A) 18%
B) 20%
C) 27%
D) 81%

Answer 2

D

Question 3

What are the two most common reasons for a sovereign debt crisis?

Answer 3

Chronic government budget deficits that eventually result in the interest payments required on government bonds taking up an unsustainably large fraction of government spending,or a severe recession that increases government spending and reduces tax revenues,resulting in soaring budget deficits.

Question 4

Banks face liquidity risk because

A) they can have difficulty meeting their depositor's demands to withdraw money.
B) they are unable to borrow from the Federal Reserve.
C) households and businesses may seek to borrow a large amount of funds in a short period of time.
D) governments tend to run high budget deficits.

Question 5

Why do governments want to maintain the health of the banking system?

Question 6

By how much did real GDP decline between 1929 and 1933?

A) 18%
B) 20%
C) 27%
D) 81%

Question 7

Why do banking panics normally lead to recessions?

Question 8

Banks have a maturity mismatch since

A) they borrow long term, but lend short term.
B) they borrow short term, but lend long term.
C) some of their loans are short term while others are long term.
D) some of their borrowings are short term while others are long term.

Question 9

What actions must a central bank take if it is trying to maintain a pegged exchange rate,but there's downward pressure on the value of its currency.

Question 10

The era of bank panics in the United States was effectively ended by

A) establishing the Fed as lender of last resort.
B) implementing the gold standard.
C) abandoning the gold standard.
D) introducing deposit insurance.

Question 11

The creation of a lender of last resort in the United States

A) occurred in response to banking panics.
B) was mandated in the U.S. Constitution.
C) occurred in response to the S&L crisis of the 1980s.
D) has been recommended by the Treasury in its report of late 1992.

Question 12

Congress created the Federal Reserve System

A) to serve as a lender of last resort.
B) to process the receipt of taxes received by the Internal Revenue Service.
C) to regulate the value of the U.S. dollar against foreign currencies.
D) to provide a source of mortgage loans to the residential housing market.

Question 13

What are the likely effects of a sovereign debt crisis in terms of the government's ability to finance its debt?

Question 14

The process by which simultaneous withdrawals by a particular bank's depositors results in the bank closing is known as a

A) contagion.
B) bank run.
C) financial crisis.
D) bank panic.

Question 15

Research by Reinhart and Rogoff indicate that most of the increase in national debt as a result of a financial crisis is due to

A) government bail outs of financial institutions.
B) increase spending on social welfare programs.
C) government stimulus programs.
D) sharp declines in tax revenues.

Question 16

The original intention of the Fed's role as lender of last resort was to make loans to banks that were

A) not illiquid nor insolvent.
B) illiquid, but not insolvent.
C) insolvent, but not illiquid.
D) both illiquid and insolvent.

Question 17

What are two ways that governments can prevent banking panics?

Question 18

Sovereign debt refers to

A) debt owned by the government.
B) bonds issued by the government.
C) debt owed to the government.
D) debt only issued by nations with kings or queens.

Question 19

Why might a nation seek to maintain a pegged exchange rate?

A) It makes business planning easier for firms involved in the global economy.
B) It removes the need to intervene in the foreign exchange market.
C) It ensures that the exchange rate will remain at its equilibrium.
D) It makes their currency more attractive on the foreign exchange market.

Question 20

A bank panic occurs when

A) a bank is worried that its loans will not be repaid.
B) an individual bank cannot meet its reserve requirements.
C) a bank lacks sufficient funds with which to make loans.
D) the situation in which many banks experience a bank run simultaneously.

Question 21

The recession that became the Great Depression began

A) two months prior to the stock market crash of 1929.
B) with the stock market crash of 1929.
C) one year after the stock market crash of 1929.
D) with the banking panics of the early 1930s.

Question 22

In what year did the economy return to normal conditions following the Great Depression?

A) 1933
B) 1937
C) 1941
D) 1945

Question 23

Describe the debt-deflation process.

Question 24

Which investment bank avoided bankruptcy by being purchased by JP Morgan Chase in March 2008?

A) Morgan Stanley
B) Lehman Brothers
C) Bear Stearns
D) Merril Lynch

Question 25

Which investment caused the Reserve Primary Fund to incur heavy losses?

A) mortgage-backed securities
B) real estate investment trusts
C) commercial paper issued by Bear Stearns
D) commercial paper issued by Lehman Brothers

Question 26

What are the four explanations given as to why the Fed did not intervene to stabilize the banking system during the Great Depression?

Question 27

All of the following were actions taken by the government or the Fed in response to the Financial Crisis of 2007-2009 EXCEPT

A) purchasing of most toxic assets such as mortgage-backed securities.
B) reducing the federal funds rate to near zero.
C) insuring deposits in money market mutual funds.
D) effective nationalization of Fannie Mae and Freddie Mac.

Question 28

Banks with which type of loans were most likely to fail during the early 1930s?

A) mortgage loans
B) agricultural loans
C) commercial real estate loans
D) international loans

Question 29

By the summer of 2008,about what percent of subprime mortgages were overdue by at least 30 days?

A) 10%
B) 25%
C) 34%
D) 50%

Question 30

What does it mean for a money market mutual fund to "break the buck"?

A) The value of its share declines below $1.
B) It incurs losses on its investments.
C) It increases its fees to more than 1% of net asset value.
D) It is unable to meet the demand for withdrawals by investors.

Question 31

What was the purpose of the stress test administered by the Treasury in 2009?

A) Evaluate potential losses of Fannie Mae and Freddie Mac.
B) Assess the viability of AIG.
C) Gauge how well the largest financial firms would fare if the recession deepened.
D) Evaluate the solvency of the major investment banks.

Question 32

How does deflation affect those with debt?

Question 33

What happened to real interest rates during the early 1930s?

A) They declined as nominal interest rates declined.
B) They rose as nominal interest rates rise.
C) They declined due to deflation.
D) They rose due to deflation.

Question 34

In what ways did the stock market crash of 1929 increase the severity of the downturn?

Question 35

Many economists believe

A) the Fed could have reduced the severity of the Great Depression by raising interest rates.
B) the Fed could have reduced the severity of the Great Depression by encouraging banks to make fewer loans to insolvent businesses.
C) bank failures increased the severity of the Great Depression.
D) the severity of the Great Depression and the policies of the Fed were unrelated.

Question 36

Which of the following did NOT significantly exacerbate the banking crisis of the early 1930s?

A) The Fed's decision not to make loans to insolvent banks.
B) The large number of small, poorly diversified banks.
C) The large number of rural banks that held agricultural loans during a time of falling commodity prices.
D) The large amount of fraud carried out by bank managers.

Question 37

Which of the following occurred following the failure of the Bank of the United States in 1930?

A) Interest rates on low-grade corporate bonds rose relative to high-rated corporate bonds.
B) Other banks in New York City suffered liquidity problems.
C) A bank panic ensued within days.
D) The stock market crashed.

Question 38

During the Great Depression,unemployment peaked at

A) 10%.
B) between 15 and 20%.
C) over 20%.
D) 81%.

Question 39

Who was the effectively in charge of the Fed during the early 1930s?

A) Secretary of Treasury
B) Head of the Federal Reserve bank of New York
C) Comptroller of the Currency
D) no one

Question 40

Why was the Fed reluctant to rescue insolvent banks?

A) It thought it may lead to moral hazard.
B) It thought it may lead to adverse selection.
C) It thought they were still liquid.
D) It did not think they were insolvent.

Question 41

How does the relationship between housing prices and rental rates provide evidence for or against the existence of a housing bubble?

Question 42

The usual response of the banking system to new government regulations is

A) evasion through whatever means are necessary.
B) strict compliance.
C) an attempt to circumvent the regulations through financial innovation.
D) bankruptcy.

Question 43

The third stage in the regulatory process is

A) a crisis.
B) response by the financial system.
C) regulation.
D) regulatory response.

Question 44

Negotiable certificates of deposit differ from demand deposits in that they

A) are not subject to early withdrawal penalties.
B) may be bought and sold in the secondary market.
C) generally have lower interest rates.
D) are not subject to state and local income taxes.

Question 45

Disintermediation refers to the

A) failure of financial intermediaries due to moral hazard problems.
B) failure of financial intermediaries due to adverse selection problems.
C) movement of savers and borrowers from banks to financial markets.
D) removal of government regulations of financial intermediaries.

Question 46

The Franklin National Bank Crisis had its greatest impact on the market for

A) commercial paper.
B) commodity futures.
C) negotiable certificates of deposit.
D) Eurodollars.

Question 47

The second stage in the regulatory process is

A) a crisis.
B) regulation.
C) response by the financial system.
D) regulatory response.

Question 48

The first stage in the regulatory process is

A) a crisis.
B) response by the financial system.
C) regulation.
D) regulatory response.

Question 49

Most of the TARP funds were used to

A) fund a stimulus package.
B) pay for losses incurred by Fannie Mae and Freddie Mac.
C) finance the operations of the Federal Reserve.
D) make direct purchases of preferred stock in banks to increase their capital.

Question 50

Which of the following statements about the Penn Central Railroad crisis is NOT true?

A) The crisis resulted in a large decline in commercial paper lending.
B) The crisis was ended by the Fed making credit available to commercial banks.
C) During the crisis, banks made loans to companies that would normally have used the commercial paper market.
D) The Fed's charter greatly restricted the number of banks to which it could make loans.

Question 51

The fourth stage in the regulatory process is

A) a crisis.
B) response by the financial system.
C) regulation.
D) regulatory response.

Question 52

Negotiable certificates of deposit were developed in order to

A) compete for loan business that had been going to the commercial paper market.
B) circumvent interest rate regulations on deposits.
C) increase assets that were acceptable as collateral for discount loans.
D) circumvent reserve requirements.

Question 53

Losses in which holding resulted in BNP Paribas not allowing investors to redeem shares from three of its investment funds?

A) mortgage-backed securities
B) Lehman Brothers
C) Bear Stearns
D) Real Estate Investment Trusts

Question 54

NOW accounts were developed in order to

A) circumvent Regulation Q.
B) provide banks with a checkable deposit on which they did not have to pay interest.
C) provide banks with a liquid, interest-earning asset.
D) provide banks with a means of earning interest on the funds in their reserve accounts with the Fed.

Question 55

Negotiable order of withdrawal accounts

A) are available only to large depositors.
B) are like checking accounts, but may not legally pay interest.
C) first appeared in New England during the early 1970s.
D) were declared illegal in the Depository Institution Deregulation and Monetary Control Act of 1980.

Question 56

Regulation Q was intended to

A) maintain banks' profitability by limiting competition for funds.
B) increase the reserves banks would hold against demand deposits.
C) increase the reserves banks would hold against time deposits.
D) eliminate the need for discount loans.

Question 57

Regulation Q

A) prohibited interstate banking.
B) placed ceilings on allowable interest rates on time and savings deposits.
C) required all banks to hold reserves against demand deposits.
D) broadened the basis on which the Fed could make discount loans.

Question 58

The primary motive for financial innovation during the regulatory process is

A) profit.
B) adherence to the new regulations.
C) return to the way business was conducted prior to the new regulations.
D) increase coordination with other financial institutions.

Question 59

What other markets were affected by the decline in the housing market beginning in 2006? Briefly explain why.

Question 60

Which of the following factors contributed to the problems that banks began to face during the 1960s and 1970s?

A) very low interest rates
B) very low inflation rates
C) banking regulations enacted during the 1930s
D) prolonged periods of recession

Question 61

In 1971 money market mutual funds were introduced as an alternative to

A) commercial paper.
B) Treasury bills.
C) repurchase agreements.
D) bank deposits.

Question 62

Which aspects of a bank's operations are evaluated as part of the CAMELS rating system?

Question 63

An ATS account

A) converts a corporation's checking account balance at the end of the day into an overnight repurchase agreement.
B) is the name given to NOW accounts outside of New England.
C) are negotiable certificates of deposit of less than $100,000.
D) were used during the Great Depression by depositors who had lost faith in conventional checking accounts.

Question 64

In late 1998 the Fed averted a possible financial panic by

A) lowering interest rates.
B) raising interest rates.
C) using its influence to bring together the creditors of Long-Term Capital Management.
D) using its influence to encourage banks to make loans to broker-dealers in the securities industry.

Question 65

Describe the four stages of the financial regulatory pattern.

Question 66

When did Regulation Q finally disappear?

A) 1934
B) 1945
C) 1986
D) 2000

Question 67

What are the primary reasons for and against a policy of "too big to fail."