Question 1

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?
A)the increasing share of 30-year, fixed rate loans as a share of outstanding mortgages
B)the rigid standards of rating agencies, such as Moody's and Standard and Poors, which limited the development of mortgage-backed securities
C)the price-stability policies of the Federal Reserve during 1998-2008
D)the erosion of lending standards during the preceding decade

Accepted Answer

The erosion of lending standards during the preceding decade contributed to the rising default and foreclosure rates beginning in the latter half of 2006. Lenders had relaxed their standards, making it easier for individuals to acquire mortgage loans that they could not afford, resulting in a significant number of defaults and foreclosures.

Question 2

Which of the following is most likely to result from a rising household debt/income ratio?
A)Household income will rise rapidly.
B)Household consumption will fall as a share of income.
C)Households will be in a better position to deal with unexpected events that force major adjustments.
D)A larger share of household income will be required to meet interest payments on debt.

Accepted Answer

A rising household debt/income ratio indicates that households are taking on more debt relative to their income. This means that a larger share of household income will be required to meet interest payments on debt, reducing the amount of income available for consumption or savings.

Question 3

Which of the following is true of regulation?
A)Regulatory agencies often ignore the secondary effects of their actions and fail to foresee future problems.
B)Policy-makers are hesitant to call for new regulations even when it is clear they would help avert future crises.
C)Mortgage lending and banking have historically been unregulated and therefore regulation in these sectors will be unpopular.
D)Past regulations have been effective at averting crises, but they are unpopular because they reduce the profitability of the regulated industry.

Accepted Answer

The answer of Which of the following is true of...

Question 4

Between 2001-2005,
A)both sub-prime and adjustable rate mortgages decreased as a share of the total.
B)both sub-prime and adjustable rate mortgages increased as a share of the total.
C)sub-prime loans increased, but adjustable rate loans decreased as a share of the total.
D)sub-prime loans decreased, but adjustable rate loans increased as a share of the total.

Accepted Answer

The answer of Between 2001-2005,
A)both sub-prime and adjustable rate mortgages...

Question 5

Which of the following reforms would reduce the likelihood of a future financial crisis?
A)increased regulations that would make it more difficult for lenders to foreclose on borrowers who are delinquent on mortgage payments
B)expansion of government-sponsored lending in order to make loanable funds more readily available to sub-prime borrowers
C)institutional changes that would strengthen the property rights of shareholders and provide financial managers with a stronger incentive to pursue long-run objectives
D)frequent regulatory changes in order to search for and find the combination that would be most effective

Accepted Answer

Institutional changes that strengthen the property rights of shareholders and provide financial managers with a stronger incentive to pursue long-run objectives can reduce the likelihood of a future financial crisis by promoting responsible decision-making and risk management. Options A and B can lead to the accumulation of risky loans and defaults, exacerbating the likelihood of a financial crisis. Option D may create regulatory uncertainty, making it difficult for financial institutions to make long-term plans and investments.

Question 6

After new HUD guidelines were issued in 1999, Freddie Mac and Fannie Mae
A)extended fewer loans to borrowers making a down payment of 5 percent or less.
B)extended more loans to borrowers making a down payment of 5 percent or less.
C)extended new loans only to borrowers making a down payment of at least 20 percent.
D)refused to extend new loans without full verification that the borrower had prime credit status.

Accepted Answer

The answer of After new HUD guidelines were issued in...

Question 7

The increase of sub-prime (including Alt-A) loans as a share of the total from 2001-2005 was an important contributing factor to the economic crisis of 2008 because
A)these loans initially reduced the demand for housing.
B)these loans initially reduced housing prices.
C)the default and foreclosure rates on these loans are several times higher than conventional loans to prime borrowers.
D)the default and foreclosure rates on these loans are considerably lower than conventional loans to prime borrowers.

Accepted Answer

The default and foreclosure rates on sub-prime loans, including Alt-A loans, were much higher than conventional loans to prime borrowers. This led to a significant number of foreclosures, which in turn caused a decline in housing prices and a decrease in the value of mortgage-backed securities. This wave of defaults and foreclosures eventually spread to the broader financial system, contributing to the economic crisis of 2008.

Question 8

The leverage ratio of an investment firm refers to
A)the ratio of its investment holdings relative to its vault cash.
B)the ratio of its investment holdings relative to its capital.
C)the percentage of deposits held by the firm relative to its deposits with Federal Reserve banks.
D)the percentage of down payments made to the investment firm relative to the size of mortgages issued by the firm.

Accepted Answer

The leverage ratio of an investment firm refers to the amount of capital it has in relation to its investment holdings. This ratio is important because it shows how much risk the firm is taking on with its investments. A higher leverage ratio means the firm has more debt relative to its equity and is therefore more risky. A lower leverage ratio means the firm is less risky but may have less potential for high returns.

Question 9

Which of the following was a contributing factor to the housing boom and bust and the financial crisis of 2008?
A)An increase in the share of loans to sub-prime borrowers.
B)An increase in the share of loans extended to borrowers making only a small down payment.
C)An increase in adjustable-rate mortgages (ARMs) as a share of the total.
D)All of the above.

Accepted Answer

All of the factors listed contributed to the housing boom and bust and the financial crisis of 2008. The increase in the share of loans to sub-prime borrowers meant that lenders were giving mortgages to people with poor credit histories or low incomes, who were more likely to default on their loans. The increase in the share of loans extended to borrowers making only a small down payment meant that many borrowers had little equity in their homes, leaving them vulnerable if housing prices declined. The increase in adjustable-rate mortgages (ARMs) as a share of the total meant that many borrowers ended up with higher mortgage payments than they could afford when interest rates rose. These factors, along with others, led to a sharp decline in housing prices and a wave of foreclosures, which in turn contributed to the financial crisis of 2008.

Question 10

The increase in the share of loans extended to borrowers with little or no down payment contributed to the financial crisis of 2008 because these loans
A)initially depressed housing prices.
B)were extended only to borrowers with prime credit status.
C)had much higher default rates than loans to borrowers making larger down payments.
D)were unavailable to low-income borrowers, who would have profited the most from such loans.

Accepted Answer

Loans extended to borrowers with little or no down payment had much higher default rates than loans to borrowers making larger down payments. These subprime loans had lower credit quality and higher risk of default, ultimately contributing to the financial crisis of 2008.

Question 11

The strong demand for housing, rising housing prices, and a construction boom from 2000 to 2005 were a result of
A)market forces that were eventually cut short by the stock market crash of 2008.
B)policy changes that had positive initial effects, but negative long-term effects.
C)tightened mortgage lending standards that reduced the risks of obtaining a home mortgage.
D)the rising interest rates of that period, which increased the demand for housing.

Accepted Answer

The answer of The strong demand for housing, rising housing...

Question 12

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to
A)shift other forms of debt to their home mortgage.
B)increase the equity in their house.
C)make larger payments and pay down their mortgage loan more rapidly.
D)decrease the overall amount of household debt in relation to household income.

Accepted Answer

Tax deductibility of interest payments on home mortgages and home equity loans encourages households to shift other forms of debt to their home mortgage to take advantage of the tax deductions. This could include credit card debt, car loans, or other unsecured loans.

Question 13

Since 2002, the Fed has shifted to expansionary monetary policy, then to restrictive policy, and then back to expansionary monetary policy. Policy shifts of this type are most likely to
A)promote economic stability and stimulate employment.
B)keep the general level of prices relatively stable because the periods of restrictive policy will just offset the periods of expansion.
C)help promote economic stability because changes in monetary policy can be counted on to exert a predictable impact on the economy quickly.
D)promote instability because the time lags of monetary policy are long and variable.

Accepted Answer

The answer of Since 2002, the Fed has shifted to...

Question 14

The share of new loans with a down payment of 5 percent or less extended by Freddie Mac and Fannie Mae
A)declined substantially after 1999.
B)rose from 4 percent in 1998 to 12 percent in 2003 and 23 percent in 2007.
C)rose from 4 percent in 1998 to 23 percent in 2002, but declined to less than 10 percent in 2007.
D)never exceeded 10 percent of the new loans financed.

Accepted Answer

According to the information given, the share of new loans with a down payment of 5 percent or less extended by Freddie Mac and Fannie Mae rose from 4 percent in 1998 to 12 percent in 2003 and 23 percent in 2007.

Question 15

Which of the following describes the relationship between interest rates and interest-sensitive goods, such as housing?
A)As interest rates decline, the demand for interest-sensitive goods increases.
B)As interest rates decline, the demand for interest-sensitive goods decreases.
C)As interest rates increase, the demand for interest-sensitive goods increases, driving prices upward.
D)As interest rates increase, the demand for interest-sensitive goods decreases, driving prices upward.

Accepted Answer

As interest rates decline, the cost of borrowing decreases, making it more affordable for individuals to purchase interest-sensitive goods such as housing. This leads to an increase in demand and, in turn, an increase in prices. Therefore, option A is the correct choice.

Question 16

Residential mortgages historically carried a capital requirement of 4 percent. Why did these mortgages, bundled as part of the mortgage-backed securities issued by investment banks, turn out to be far more risky than historically indicated?
A)Rating agencies miscalculated the historical risk of traditional fixed-rate residential mortgages.
B)Investment banks leveraged these mortgage-backed securities more than was allowable under SEC rules.
C)Lower mortgage lending standards increased the likelihood that defaults would occur.
D)Investment banks held too much capital relative to these mortgage-backed securities.

Accepted Answer

Lower mortgage lending standards, including offering mortgages to subprime borrowers with poor credit history, increased the likelihood of defaults and added significant risk to the mortgage-backed securities. This was a contributing factor to the 2008 financial crisis.

Question 17

Adjustable rate mortgages became increasingly attractive and grew as a percentage of total outstanding mortgages during 2002 to 2004 because
A)interest rates were kept artificially low during this period.
B)interest rates rose sharply during this period.
C)lending standards were tightened during this period.
D)housing prices declined during this period.

Accepted Answer

Adjustable rate mortgages (ARMs) have interest rates that are tied to a benchmark rate, typically the Prime Rate, and can fluctuate over time. During the period of 2002 to 2004, the Federal Reserve kept interest rates artificially low to boost economic growth after the dot-com bubble burst. This made adjustable rate mortgages very attractive to borrowers who were able to secure lower interest rates than they would have with a fixed-rate mortgage. As a result, ARMs grew as a percentage of total outstanding mortgages during this period.

Question 18

The Fed's low short-term interest rate policy from 2002-2004, along with housing regulations promoting low down-payment loans to sub-prime borrowers, encouraged
A)conventional 30-year, fixed rate mortgages which have relatively high default and foreclosure rates.
B)conventional 30-year, fixed rate mortgages which have relatively low default and foreclosure rates.
C)adjustable rate mortgages which have relatively low default and foreclosure rates.
D)adjustable rate mortgages which have relatively high default and foreclosure rates.

Accepted Answer

The Fed's low short-term interest rate policy incentivized borrowers to obtain adjustable-rate mortgages (ARMs) which have lower initial interest rates but can adjust upwards over time. Housing regulations also promoted low down-payment loans to sub-prime borrowers, many of whom were not able to keep up with payments when their ARMs adjusted upwards. This led to a higher rate of default and foreclosure for ARMs compared to traditional fixed-rate mortgages.

Question 19

Which of the following contributed to the rising mortgage default and foreclosure rates and the eventual economic crisis of 2008?
A)tightened mortgage lending standards and the reduction of loanable funds during 2001-2005
B)the increase in the greed of Wall Street bankers and other commercial lenders
C)the substantial increase in sub-prime and adjustable rate mortgages as a share of the total during 2001-2006
D)the increase in the household savings rate during the two decades following 1985
E)the increase in fixed rate mortgages as a share of the total during the decade prior to the crisis

Accepted Answer

The substantial increase in sub-prime and adjustable rate mortgages as a share of the total during 2001-2006 contributed to the rising mortgage default and foreclosure rates and the eventual economic crisis of 2008. These mortgages were often given to borrowers who did not have the financial capacity to repay them, leading to high default rates and foreclosures. This, in turn, led to a decline in housing prices and the collapse of the housing market, which had ripple effects throughout the financial system. While other factors also contributed to the crisis, such as the increase in the greed of Wall Street bankers, the rise in subprime and adjustable rate mortgages was a significant driver of the crisis.

Question 20

Which of the following was an underlying cause of the economic crisis of 2008?
A)a failure of government to impose regulations on Fannie Mae, Freddie Mac, and other mortgage lenders
B)the imposition of government regulations on Fannie Mae, Freddie Mac, and other lending institutions that eroded the conventional lending standards in place prior to the mid-1990s
C)greedy mortgage lenders who extended risky loans to sub-prime borrowers even though the regulators were trying to limit these loans
D)federal housing regulations that made it difficult for Fannie Mae, Freddie Mac, and other lending institutions to obtain sufficient loanable funds for the finance of housing construction

Accepted Answer

The answer of Which of the following was an underlying...

Quiz 20: Appendix: the Crisis of 2008: Causes and Lessons for the Future

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?

Which of the following is most likely to result from a rising household debt/income ratio?

Which of the following is true of regulation?

Between 2001-2005,

Which of the following reforms would reduce the likelihood of a future financial crisis?

After new HUD guidelines were issued in 1999, Freddie Mac and Fannie Mae

The increase of sub-prime (including Alt-A) loans as a share of the total from 2001-2005 was an important contributing factor to the economic crisis of 2008 because

The leverage ratio of an investment firm refers to

Which of the following was a contributing factor to the housing boom and bust and the financial crisis of 2008?

The increase in the share of loans extended to borrowers with little or no down payment contributed to the financial crisis of 2008 because these loans

The strong demand for housing, rising housing prices, and a construction boom from 2000 to 2005 were a result of

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to

Since 2002, the Fed has shifted to expansionary monetary policy, then to restrictive policy, and then back to expansionary monetary policy. Policy shifts of this type are most likely to

The share of new loans with a down payment of 5 percent or less extended by Freddie Mac and Fannie Mae

Which of the following describes the relationship between interest rates and interest-sensitive goods, such as housing?

Residential mortgages historically carried a capital requirement of 4 percent. Why did these mortgages, bundled as part of the mortgage-backed securities issued by investment banks, turn out to be far more risky than historically indicated?

Adjustable rate mortgages became increasingly attractive and grew as a percentage of total outstanding mortgages during 2002 to 2004 because

The Fed's low short-term interest rate policy from 2002-2004, along with housing regulations promoting low down-payment loans to sub-prime borrowers, encouraged

Which of the following contributed to the rising mortgage default and foreclosure rates and the eventual economic crisis of 2008?

Which of the following was an underlying cause of the economic crisis of 2008?