Deck 18: The Financial Crisis of 2007-2009

Question 1

In the early 2000s,banks lowered lending standards to comply with the Community Reinvestment Act.

Answer 1

True

Question 2

According to economist John Taylor,the Fed set its federal funds rate target too high during the period 2002-early 2006,which contributed to the financial crisis of 2007-2009.

Answer 2

False

Question 3

A bank is solvent as long as its liabilities are greater than its assets.

Answer 3

False

Question 4

The _______________________ (TARP)is an example of a government program created to help stabilize the financial sector during the financial crisis of 2007-2009.

A)Times Are Really Problematic
B)Tarnished Assets Recovery Program
C)Troubled Assessments Recovery Program
D)Troubled Assets Relief Program

Question 5

For financial institutions,securitization is the means by which regulatory capital arbitrage lowers capital requirements.

Question 6

A bank has $200 million in assets and $150 million in liabilities.The banks net worth is _____________ million and its leverage ratio is __________________.

A)$350;0.56 to 1
B)$175;1.14 to 1
C)$50;4 to 1
D)$25;8 to 1

Question 7

In the early 2000s,Fannie Mae and Freddie Mac came under political pressure to buy nontraditional loans.

Question 8

Rising savings rates in emerging countries in the period 2000-2008 are associated with both falling and rising mortgage interest rates in the United States.

Question 9

A bank initially has $190 million in assets and $150 million in liabilities.The banks net worth (capital)is _____________ million.If the bank's assets increase by 10% and its liabilities do not change,its capital increases by ____________ .

A)$340;10%
B)$40;47.5%
C)$40;10%
D)$40;32.2%

Question 10

The downside to a bank having a high leverage ratio is that a decline in asset value magnifies losses.

Question 11

A bank has $390 million in assets and $330 million in liabilities.The bank's net worth is _____________ million and its leverage ratio is __________________.

A)$360;1.08 to 1
B)$60;0.15 to 1
C)$40;3.75 to 1
D)$60;6.5 to 1

Question 12

During a time of rising asset values,a bank can increase its returns by engaging in regulatory capital arbitrage.

Question 13

Regulatory capital is the amount of capital financial institutions should hold based on the riskiness of their different assets.

Question 14

Insolvency is a condition where a firm's

A)liabilities are greater than assets.
B)assets are greater than liabilities.
C)assets are equal to liabilities.
D)liabilities are less than or equal to assets.

Question 15

When housing prices rise,homeowners gain equity in their homes.

Question 16

If the value of a bank's assets is rising,a high leverage ratio increases the percentage rise in its capital.

Question 17

A bank initially has $250 million in assets and $200 million in liabilities.The banks net worth (capital)is _____________ million.If the bank's assets decline by 10% and its liabilities do not change,its capital decreases by ____________ .

A)$50;50%
B)$50;100%
C)$50;10%
D)$450;10%

Question 18

In February 2009,Congress passed (and President Obama signed)a $787 billion fiscal stimulus bill in an attempt to improve the economy.

Question 19

If nominal GDP is declining,it is necessarily true that Real GDP is also declining.

Question 20

A bank initially has $620 million in assets and $580 million in liabilities.The banks net worth (capital)is _____________ million.If the bank's assets decline by 5% and its liabilities do not change,its capital decreases by ____________ .

A)$40;5%
B)$70;141.4%
C)$40;77.5%
D)$600;5%

Question 21

Regulatory capital arbitrage is a means of

A)using borrowed funds to increase the returns that can be earned with a given amount of capital.
B)specifying the amount of capital that financial institutions should hold based on the riskiness of their different assets.
C)determining mortgage rates for sub-prime borrowers.
D)changing the composition of assets in such a way as to lower the overall amount of capital a financial institution holds for a given level of assets.

Question 22

__________________ capital specifies the amount of capital financial institutions should hold based on the riskiness of their assets.

A)Regulatory
B)Securitization-based
C)Risk-based
D)Leverage-based

Question 23

Which of the following is an example of a participant in the financial sector?

A)commercial banks
B)investment banks
C)hedge funds
D)brokerage firms
E)all of the above

Question 24

In the 1990s and early 2000s,mortgage lending standards ______________ in the United States.In general,there was a move _____________ traditional lending practices during this period.

A)declined;away from
B)declined;towards more
C)became more strict;away from
D)became more strict;towards more

Question 25

Former Fed Chairman Alan Greenspan has argued that low ___________ interest rates,not ______________ interest rates,were the cause of the housing boom in the late 1990s and early 2000s.He also argued that the Fed has more control over _______________ rates than over ____________ rates.

A)long-term;short-term
B)long-term;long-term
C)short-term;short-term
D)short-term;long-term

Question 26

The Community Reinvestment Act (CRA)was passed in 1977 to encourage financial institutions to_________________________.It was revised in 1995 to ____________ the percentage of mortgage loans going to low- and moderate-income borrowers.

A)lend to only the most qualified borrowers;increase
B)meet the needs of borrowers in all segments of their communities;decrease
C)meet the needs of borrowers in all segments of their communities;increase
D)lend to only the most qualified borrowers;decrease

Question 27

One of the contributing factors to the financial crisis of 2007-2009 was that mortgage lending practices were ____________ strict in the late 1990s and early 2000s,compared to earlier periods such as the 1970s and 1980s,which led to a(n)_______________ in subprime and other nontraditional mortgage loans.

A)less;increase
B)more;increase
C)less;decline
D)more;decline

Question 28

According to John Taylor,during the period 2002-early 2006 the Fed set its federal funds rate target _____________ the rate that would have existed had the Fed set its target using the Taylor rule.

A)below
B)above
C)equal to
D)sometimes below and sometimes above

Question 29

The ability of banks to get insurance from ______________ encourages banks to take on a little bit _________ risk than they would in the absence of deposit insurance.

A)the FDIC;less
B)Fannie Mae (FNMA);more
C)the FDIC;more
D)Fannie Mae (FNMA);less

Question 30

Securitization is the process by which financial institutions

A)pool together a group of loans and then issue securities backed by the pool.
B)determine the composition of their assets that will yield the optimal amount of security for their financial health.
C)borrow funds from the Federal Reserve and then use those funds to make loans to their customers.
D)determine sub-prime mortgage rates.

Question 31

During the early 2000s the Fed's __________ federal funds rate targets led to a ___________ in mortgage interest rates.

A)low;rise
B)high;rise
C)low;rise
D)low;decline

Question 32

The Federal National Mortgage Association (FNMA),also known as Fannie Mae,was established in ________to ____________ demand in the housing market.

A)1970;increase
B)1938;increase
C)1938;decrease
D)1970;decrease

Question 33

A bank has $200 million in assets and $230 million in liabilities.The bank's net worth is _____________ million and the bank is ____________.

A)-$215;insolvent
B)-$30;insolvent
C)$15;solvent
D)$30;solvent

Question 34

A bank has $150 million in assets and $90 million in liabilities.The bank's net worth is _____________ million and the bank is ____________.

A)$105;insolvent
B)$40;insolvent
C)$60;solvent
D)$60;solvent

Question 35

Suppose that a bank has $30 million in asset X,$10 million in asset Y,and $20 million in asset Z.Each asset has a different risk weight.The risk weight for asset X is 30%,the risk weight for asset Y is 60%,and the risk weight for asset Z is 10%.The amount of risk-weighted assets for this bank is ____________ million.Assuming that the bank has to hold capital equal to 8% of its risk-weighted assets,the bank must hold _____________ million in capital.

A)$17;$13,6
B)$60;$4.8
C)$17;$1.36
D)$66;$5.28

Question 36

According to John Taylor (for whom the Taylor rule is named),during the period 2002-early 2006 actual Fed policy was "too_________" ,which he believes led to both interest rates being "too ________" and rising housing prices in the United States.

A)contractionary;high
B)contractionary;low
C)expansionary;low
D)expansionary;high

Question 37

There are some economists who argue that low mortgage interest rates in the time period preceeding the financial crisis of 2007-2009 were a result of a ___________ in global savings.They argue that emerging countries began to save ___________ which helped to _____________ the supply of loanable funds in the United States.

A)glut;less;decrease
B)glut;more;increase
C)decline;more;increase
D)decline;less;decrease

Question 38

A ____________________ loan is a nontraditional mortgage loan granted to persons who have some factor,such as low credit ratings,which suggest that they could default on the repayment of their debt.

A)mortgage-backed security
B)collateralized
C)subprime mortgage
D)risk-based mortgage

Question 39

Some economists argue that the Fed set its federal funds rate target "too _________" in the early 2000s,which was one of the contributing factors which led to ____________ mortgage interest rates and a(n)___________ housing prices.

A)low;low;increase
B)low;low;decline
C)high;high;decline
D)high;high;increase

Question 40

Suppose that a bank has $500 million in asset X,$400 million in asset Y,and $200 million in asset Z.Each asset has a different risk weight.The risk weight for asset X is 40%,the risk weight for asset Y is 70%,and asset Z has zero risk.The amount of risk-weighted assets for this bank is ____________ million.Assuming that the bank has to hold capital equal to 8% of its risk-weighted assets,the bank must hold _____________ million in capital.

A)$480;$38.4
B)$1,100;$88
C)$1,100;$880
D)$340;$27.2

Question 41

A bank with a leverage ratio of 9 to 1 has

A)$9 in assets for every $1 in liabilities.
B)$9 in assets for every $1 in capital.
C)$1 in assets for every $9 in capital.
D)$1 in assets for every $9 in liabilities.

Question 42

Which of the following statements is false?

A)In 2006,some people with subprime and other nontraditional loans were not able to make their monthly payments on their mortgage loans.
B)The leverage ratio is the ratio of assets to capital.
C)John Taylor argued that the global savings glut was the reason for the low interest rates in the early-2000s and for the rise in housing prices that followed.
D)It is possible for a bank to have the value of its liabilities greater than the value of its assets.
E)none of the above

Question 43

Collateralized debt obligations are

A)like mortgage-backed securities except that the slices are equal.
B)like mortgage-backed securities except that the slices are unequal.
C)an asset for persons who buy them.
D)b and c
E)a and c

Question 44

What does the term run on the bank mean?

A)People will rush in to deposit money in the bank.
B)People will rush to buy the bank's stock.
C)Depositers of the bank will rush in to close out their accounts at the bank.
D)Depositers of the bank will rush in to add money to the accounts they already have with the bank.
E)none of the above

Question 45

The answer is,"They are mortgage loans granted to persons who might have low credit ratings." The question is:

A)What are traditional loans?
B)What are collateralized debt obligations?
C)What are subprime mortgage loans?
D)What are securitized loans?

Question 46

Which of the following is more nearly consistent with a global savings glut?

A)high interest rates and the global savings-World GDP ratio is low
B)low interest rates and the global savings-World GDP ratio is low
C)high interest rates and the global savings-World GDP ratio is high
D)low interest rates and the global savings-World GDP ratio is high
E)none of the above

Question 47

According to Alan Greenspan,the Taylor rule is ________________ when trying to figure out the causes of sharp increases in housing prices.His opinion is based,in part,on his assertion that the Taylor rule addresses ____________ inflation,not ____________ inflation.

A)inappropriate;product-price;asset-price
B)inappropriate;asset-price;product-price
C)appropriate;product-price;asset-price
D)appropriate;asset-price;product-price

Question 48

As a bank approaches insolvency,it is likely to

A)decrease its lending activities.
B)increase its lending activities.
C)find that its capital is declining.
D)try to increase its liabilities
E)a and c

Question 49

When we say that the financial crisis can be viewed as a balance sheet problem,this is descriptive of

A)banks' assets being greater than their liabilities.
B)banks possessing assets that are declining in value,resulting in banks approaching insolvency.
C)banks having low leverage ratios.
D)banks engaging in regulatory capital arbitrage.
E)none of the above

Question 50

A bank with a leverage ratio of 6.5 to 1 has

A)$6.50 in assets for every $1 in liabilities.
B)$6.50 in assets for every $1 in capital.
C)$1 in assets for every $6.50 in capital.
D)$1 in assets for every $6.50 in liabilities.

Question 51

When borrowers are unable to make their monthly mortgage payments,the value of mortgage-backed securities and collateralized debt obligations

A)falls,which pushes banks that own them closer to insolvency.
B)rises,which pushes banks that own them closer to insolvency.
C)falls;which pushes banks that own them towards greater solvency.
D)rises,which pushes banks that own them towards greater solvency.

Question 52

With collateralized debt obligations (CDOs)buyers are purchasing _________ slices,and buyers of mortgage-backed securities (MBSs)purchase ___________ slices.

A)unequal;equal
B)equal;equal
C)unequal;unequal
D)equal;unequal

Question 53

The Taylor rule is a recommendation of how

A)banks should determine worthy loan recipients.
B)the Fed should set the required reserve ratio.
C)the Fed should set the federal funds rate target.
D)banks should securitize their debt.

Question 54

A subprime mortgage loan is a loan granted to persons who

A)have unusually good credit ratings and who represent a very low risk of default on the debt repayment.
B)are borrowing funds to purchase a business,rather than a home.
C)might have low credit ratings or some other factors that lead lenders to believe that they could default on the debt repayment.
D)work for the government,rather than those who work in the private sector.

Question 55

In the early 2000s,the Fed's ____________ interest rate policy had several effects.Among these effects were a _______________ in mortgage interest rates and a(n)____________ in the size of loans taken out by mortgage borrowers.

A)high;decline;decrease
B)low;decline;increase
C)low;rise;increase
D)high;rise;increase

Question 56

International standards for risk-based capital requirements were introduced under the

A)Federal Reserve Act of 1913.
B)1988 Basel Accord
C)Community Reinvestment Act of 1977.
D)Federal Deposit Insurance Act of 2008.

Question 57

Which sequence of events correctly and sequentially best describes financial sector problems spilling over to the real sector of the economy?

A)Bank assets increase,capital increases,consumers purchase less,firms lay-off workers.
B)Bank liabilities increase,capital decreases,consumers purchase more of the "wrong" products,firms lay-off some workers and hire other workers.
C)Bank assets decline in value,banks approach insolvency,banks cut back on lending,consumers purchase less,some firms produce less and other firms go out of business.
D)Banks engage in regulatory capital arbitrage,leverage ratios are rising,asset values are rising,consumers purchase less,producers produce less,firms lay-off some workers.
E)none of the above

Question 58

Bank B takes 15,000 mortgage loans,bundles them together,and then sells slices of the bundle.This is descriptive of

A)creating a mortgage-backed security.
B)creating a mortgage-backed liability.
C)buying a collateralized debt obligation.
D)selling a simple loan.
E)none of the above

Question 59

For a bank,more capital means more _____________,and it also means ___________ returns when asset values are rising.

A)risk;lower
B)risk;higher
C)safety;lower
D)safety;higher

Question 60

Which of the following bank assets declined in value in the mid-2000s?

A)subprime loans
B)mortgage-backed securities
C)collateralized debt obligations
D)nontraditional loans
E)all of the above

Question 61

Describe the differences between traditional and nontraditional lending practices.Under which category do subprime loans belong?

Question 62

Describe three of the ways that the U.S.federal government responded to the financial crisis of 2007-2009 and to the resulting problems in the real sector of the economy.Be sure to include in your answer the government's specific intent in each of these actions.

Question 63

Suppose the Fed lowers its federal funds rate target.The Fed probably seeks to

A)lower the actual federal funds rate.
B)raise the actual federal funds rate.
C)leave unchanged the actual federal funds rate
D)b or c
E)a or c

Question 64

All other things being equal among the banks below,which bank is the least likely to become insolvent?

A)Bank A with assets of $100 million and liabilities of $80 million.
B)Bank B with assets of $100 million and liabilities of $70 million.
C)Bank C with assets of $200 million and liabilities of $120 million.
D)Bank D with assets of $400 million and liabilities of $310 million.
E)Bank E with assets of $100 million and liabilities of $60 million.

Question 65

According to economist Hyman Minsky,Keynesian economics considers _____________________ as determining economic system behavior.

A)​both asset prices and output prices
B)asset prices,but not output prices,
C)​output prices,but not asset prices,
D)​neither asset prices nor output prices

Question 66

According to Alan Greenspan,the type of inflation that the Taylor Rule is best at addressing is

A)asset-price inflation
B)product-price inflation
C)both asset-price and product-price inflation
D)demand-induced-one-shot inflation
E)supply-induced one-shot inflation

Question 67

When the money supply increases at the same time that velocity is decreasing,total spending will

A)always rise.
B)always decline.
C)fall if the decrease in velocity is relatively less than the increase in the money supply.
D)fall if the decrease in velocity is relatively greater than the increase in the money supply.

Question 68

During the Great Recession,the growth rate of Real GDP _________________ and the inflation rate ___________________.

A)increased;declined
B)declined;increased
C)declined;also declined
D)increased;also increased

Question 69

Describe how,according to some economists,the Fed's actions and the"global savings glut" both contributed to rising U.S.housing prices in the early 2000s.

Question 70

Define the terms financial sector and real sector.Describe the processes by which a number of banks becoming insolvent (or approaching insolvency)can have an adverse impact on the real sector.

Question 71

If M = $1,200 billion and V = 4,then total spending is _______________billion.Then velocity falls to 2 and M rises to $2,000 billion,so that total spending is now _______________ billion,and GDP has _________________.

A)$4,800;$4,000;declined
B)$300;$1,000;risen
C)$4,800;$4,000;risen
D)$1,204;$2,002;risen