Question 1

To the extent that failure to appreciate the implications of the decline in house prices on the financial system contributed to the financial crisis of 2008-2009 in the United States,blame for this mistake lies with:

Accepted Answer

Regulators are responsible for overseeing and regulating the financial system, including the housing market. It was ultimately their failure to recognize and address the risks and consequences of declining house prices that contributed to the financial crisis. While mortgage brokers, investment banks, and homebuyers all played a role in the crisis, they were not primarily responsible for the systemic level of the failure.

Question 2

When the central bank acts as a lender of last resort,it:

Accepted Answer

When the central bank acts as a lender of last resort, it requires the borrower to put up collateral, which acts as a form of security for the loan provided. This collateral can be in the form of government securities, gold or any other high-quality assets. However, confiscating the borrower assets or taking over the ownership of the borrower are extreme measures that are unlikely to happen in most cases. The central bank also does not require voting rights on the borrower's board of directors.

Question 3

Ideally,the purpose of providing funds to insolvent banks beyond required insurance payouts is to:

Accepted Answer

The purpose of providing funds to insolvent banks beyond required insurance payouts is to prevent a domino effect of bank failures that can have severe impacts on the economy. By preventing one bank from failing, the government can avoid a chain reaction of bank failures, which could lead to a larger financial crisis. Therefore, option D is the best choice. Choices A, B and C do not accurately reflect the purpose of providing funds to insolvent banks.

Question 4

To the extent that mortgage defaults contributed to the financial crisis of 2008-2009 in the United States,blame for these actions lies with:

Accepted Answer

All of the above are responsible for mortgage defaults that led to the financial crisis of 2008-2009. Homebuyers who borrowed more than they could afford to repay took on mortgages that they could not sustain, leading to defaults. Mortgage brokers encouraged households to take out larger loans than they could handle, often through deceptive marketing tactics. Government policymakers pushed for policies that encouraged homeownership among lower-income households, leading to increased demand for housing and a subsequent increase in housing prices. All of these factors contributed to the mortgage defaults that led to the financial crisis.

Question 5

Conventional fiscal policy was limited during the 2008-2009 recession because of:

Accepted Answer

During the recession, governments were worried that implementing expansive fiscal policy would increase their budget deficit and debt levels. The growing public concern over the deficit and national debt put limits on the ability of governments to offer tax cuts and increase spending to help boost economic growth. As a result, fiscal policy was limited during the recession.

Question 6

The principal purpose of a central bank acting as a lender of last resort is to:

Accepted Answer

The principal purpose of a central bank acting as a lender of last resort is to maintain the liquidity of the financial system, ensuring that financial institutions have access to emergency funds to prevent a liquidity crisis that could lead to a systemic collapse.

Question 7

Conventional monetary and fiscal policies used in a recession are aimed at:

Accepted Answer

Conventional monetary and fiscal policies used in a recession are aimed at increasing aggregate demand. This is done by decreasing interest rates to encourage borrowing and spending, increasing government spending, and/or decreasing taxes to increase disposable income and encourage spending. By increasing aggregate demand, it is believed that economic output and employment will increase, and the recessionary gap can be closed.

Question 8

To the extent that risky mortgage-backed securities that were sold to buyers who were not fully aware of the risks contributed to the financial crisis of 2008-2009 in the United States,blame for this action lies with:

Accepted Answer

Investment banks were responsible for creating and selling risky mortgage-backed securities to buyers who were not fully aware of the risks involved. This led to the collapse of the housing market and ultimately the financial crisis of 2008-2009. While homebuyers and mortgage brokers may have played a role in the crisis, the primary responsibility lies with the investment banks who created and sold these securities. The Federal Reserve may have also played a role in the crisis through its policies and oversight, but it was not directly responsible for the creation and sale of these securities.

Question 9

Conventional monetary and fiscal policies during a financial crisis are aimed at _____,while acting as a lender of last resort or injecting government funds into the financial system during a financial crisis is aimed at _____.

Accepted Answer

Conventional monetary and fiscal policies during a financial crisis are aimed at expanding aggregate demand in order to stimulate economic growth and prevent recession. On the other hand, acting as a lender of last resort or injecting government funds into the financial system during a financial crisis is aimed at fixing the financial system and ensuring the stability of the banking system, which is critical for economic growth. Therefore, option B is the correct answer.

Question 10

A bank with assets worth less than liabilities is said to be _____,while a bank without adequate funds immediately available to make promised payments is said to be _____.

Accepted Answer

A bank with assets worth less than liabilities is insolvent, meaning it is unable to pay its debts. A bank without adequate funds immediately available to make promised payments is illiquid, meaning it has a lack of liquid funds to meet its obligations as they come due.

Question 11

When the phrase _____ was coined,it referred to _____.

Accepted Answer

The phrase "too big to fail" was first coined in reference to the Continental Illinois Bank in the 1980s.

Question 12

During the 2008-2009 period,the conventional monetary policy response was to _____ interest rates,while the conventional fiscal policy response was to _____ taxes and to _____ government spending.

Accepted Answer

During the 2008-2009 period, the Federal Reserve decreased interest rates through conventional monetary policy to stimulate borrowing and spending. Meanwhile, the government implemented conventional fiscal policy by decreasing taxes and increasing government spending to stimulate economic growth.

Question 13

A situation in which a solvent bank does not have sufficient cash on hand to satisfy the withdrawal demands of depositors is called a(n)_____ crisis.

Accepted Answer

The situation described in the question is known as a liquidity crisis, where a bank's ability to meet the demand for cash withdrawals by its depositors is compromised due to a shortage of liquid assets such as cash or easily sellable securities. Options A, B, and C may also be associated with financial crises, but they do not specifically refer to the described situation of a solvent bank facing a shortage of cash.

Question 14

To the extent that the undervaluation of the riskiness of mortgage-backed securities contributed to the financial crisis of 2008-2009 in the United States,blame for this mistake lies with:

Accepted Answer

The rating agencies were responsible for rating mortgage-backed securities as safe investments, even though they were actually much riskier. This led investors to underestimate the risk they were taking on and ultimately contributed to the financial crisis. Mortgage brokers, investment banks, and government policymakers may have played a role in the crisis, but the undervaluation of risk by rating agencies was a key factor.

Question 15

During the 2008-2009 financial crisis in the United States,the Federal Reserve served as a lender of last resort by providing liquidity to:

Accepted Answer

During the financial crisis, the Federal Reserve provided liquidity to both banks and shadow banks with reliable collateral to prevent them from collapsing and causing a systemic financial meltdown. They did not provide funding to insolvent borrowers, state and local governments, or households underwater on their mortgages.

Question 16

The phrase _____ describes a firm so central to that financial system that policymakers will not allow it to enter bankruptcy.

Accepted Answer

The phrase "too big to fail" is used to describe a firm that is considered so important to the financial system that the government will take measures to prevent it from entering bankruptcy. This phrase became well known during the financial crisis of 2008 when several large financial institutions were deemed "too big to fail" and were bailed out by the government to avoid a wider financial collapse.

Question 17

Illiquid financial institutions:

Accepted Answer

Illiquid financial institutions do not have immediately available funds to make promised payments, which can lead to a liquidity crisis. This is different from having assets worth less than liabilities or having negative net worth, which indicate insolvency. It is also possible for illiquid financial institutions to accept deposits or make loans to households, but they may have difficulty managing their cash flow in the short term.

Question 18

Conventional monetary policy was limited during the 2008-2009 recession because the central bank could not:

Accepted Answer

Conventional monetary policy involves adjusting the target interest rate to influence spending and investment in the economy. However, during the 2008-2009 recession, the target interest rate reached zero and could not be reduced further. This is known as the zero lower bound. Therefore, the central bank could not use conventional monetary policy to stimulate the economy. Options A, B, and D are not correct because the central bank could purchase bonds, print money, and adjust the discount rate, respectively, but these actions alone were not effective in overcoming the zero lower bound constraint.

Question 19

An illiquid bank can become insolvent when it:

Accepted Answer

An illiquid bank may be forced to sell assets at fire-sale prices to meet liquidity demands, which can erode the value of its assets and reduce its ability to repay its debts. This can lead to insolvency if the bank's liabilities exceed its assets, resulting in a loss of confidence from depositors and investors. Refusing to make promised payments or extending the due dates of liabilities may buy the bank time, but it does not address the root cause of the liquidity crisis and may worsen the situation in the long run. Selling additional stock to obtain funds may improve the bank's capital position, but it may not be a viable option if there is low demand or if existing shareholders are reluctant to dilute their ownership.

Question 20

When the central bank lends to financial institutions in the midst of a liquidity crisis,the central bank is acting as a:

Accepted Answer

When a central bank provides liquidity support to financial institutions in times of crisis, it is acting as a lender of last resort. This is because the central bank is the ultimate source of liquidity and can provide funds when other sources have dried up. Shadow banks are non-bank financial institutions that provide similar services to traditional banks (such as lending and investing) but are not subject to the same regulations. Investment banks are financial institutions that help companies or governments raise capital by underwriting or issuing securities. Mutual funds are investment vehicles that pool money from multiple investors to purchase a portfolio of assets.

Quiz 20: The Financial System