Deck 8: Why Do Financial Crises Occur and

Question 1

Debt deflation refers to

A) an increase in net worth, leading to a relative fall in general debt levels.
B) a decline in general debt levels due to deleveraging.
C) a decline in bond prices as default rates rise.
D) a decline in net worth as price levels fall while debt burden remains unchanged.

Answer 1

D

Question 2

What is a collateralized debt obligation?

A) A tranche of an SPV that has been setup based on default risk
B) An agreement to exchange interest payments when one party defaults
C) A type of insurance against defaults
D) A contract between credit rating agencies

Answer 2

A

Question 3

Financial crises

A) cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers.
B) are a recent phenomenon that occur only in developing countries.
C) invariably lead to debt deflation.
D) all of the above.
E) none of the above.

Answer 3

E

Question 4

Which of the following factors led up to the Greece debt crisis in 2009-2010?

A) Speculative attacks on the euro and a rise in actual and expected inflation
B) A decline in tax revenues resulting from a contraction in economic activity
C) A double-digit budget deficit
D) All of the above
E) only B and C of the above

Question 5

Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as

A) stock prices declined to 10 percent of their levels in 1929.
B) banks failed.
C) the aggregate price level declined.
D) a result of all of the above.
E) a result of A and B of the above.

Question 6

Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.

A) currency
B) stock market
C) banking
D) commodities

Question 7

Factors that lead to worsening conditions in financial markets include

A) declining interest rates.
B) anticipated increases in the price level.
C) bank panics.
D) only A and C of the above.
E) only B and C of the above.

Question 8

Which of the following led to the U.S.financial crisis of 2007-2009?

A) Financial innovation in mortgage markets
B) Agency problems in mortgage markets
C) An increase in moral hazard at credit rating agencies
D) All of the above
E) only A and B of the above

Question 9

Financial crises

A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.
B) occur when adverse selection and moral hazard problems in financial markets become more significant.
C) frequently lead to sharp contractions in economic activity.
D) are all of the above.
E) are only A and B of the above.

Question 10

The process of deleveraging refers to

A) cutbacks in lending by financial institutions.
B) a reduction in debt owed by banks.
C) both A and B.
D) none of the above.

Question 11

Factors that lead to worsening conditions in financial markets include

A) increases in interest rates.
B) declining stock prices.
C) increasing uncertainty in financial markets.
D) all of the above.
E) only A and B of the above.

Question 12

When asset prices fall following a boom,

A) moral hazard may increase in companies that have lost net worth in the bust.
B) financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging.
C) both A and B are correct.
D) none of the above are correct.

Question 13

In addition to having a direct effect on increasing adverse selection problems,increases in interest rates also promote financial crises by ________ firms' and households' interest payments,thereby ________ their cash flow.

A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing

Question 14

What is a credit boom?

A) An explosion in a credit cycle, which can increase or decrease lending in the short-run
B) Essentially a lending spree on the part of banks and other financial institutions
C) When credit card receivables rise due to low initial interest rates
D) The signal of the end of a credit spree, with credit contracting rapidly

Question 15

Stage Three of a financial crisis in an advanced economy features

A) a general increase in inflation.
B) debt deflation.
C) an increase in general price levels.
D) a full-fledged financial crisis.

Question 16

Approximately how large was the U.S.subprime mortgage market in 2007?

A) $100 million
B) $100 billion
C) $500 billion
D) $1 trillion

Question 17

Stock market declines preceded a full-blown financial crisis

A) in the United States in 1987.
B) in the United States in 2000.
C) in the United States in 1929.
D) in all of the above.
E) in none of the above.

Question 18

During the 1800s,many U.S.financial crises were precipitated by an increase in ________,often originating in London.

A) interest rates
B) housing prices
C) gasoline prices
D) heating oil prices

Question 19

Most financial crises in the United States have begun with

A) a steep stock market decline.
B) an increase in uncertainty resulting from the failure of a major firm.
C) a steep decline in interest rates.
D) all of the above.
E) only A and B of the above.

Question 20

In an advanced economy,a financial crisis can begin in several ways,including

A) mismanagement of financial liberalization or innovation.
B) asset pricing booms and busts.
C) an increase in uncertainty caused by failure of financial institutions.
D) all of the above.

Question 21

Discuss why some view the Fed as a culprit in the U.S.housing bubble during the 2000s.

Question 22

The impact of the 2007-2009 financial crisis was widespread,including

A) the first major bank failure in the UK in over 100 years.
B) the failure of Bear Stearns, the fifth-largest U.S. investment bank.
C) the bailout of Fannie Mae and Freddie Mac by the U.S. Treasury.
D) all of the above.
E) only B and C of the above.

Question 23

When we refer to the shadow banking system,what are we talking about?

A) Hedge funds, investment banks, and other nonbank financial firms that supply liquidity
B) The "underground" banking system used for illegal activities
C) The subsidiaries of depository institutions
D) None of the above

Question 24

Factors that can lead to worsening conditions in financial markets include increasing interest rates and asset price booms.

Question 25

Discuss some of the financial innovations in mortgage markets that led to the U.S.financial crisis in 2007.

Question 26

What is the problem with government safety nets,such as deposit insurance,during the formative stages of a financial crisis?

Question 27

The failure of Ohio Life Insurance and Trust in 1857 did not signal the start of a recession due to prompt actions by the Fed.

Question 28

Describe a special purpose vehicle. How are they related to the creation of collateralized debt obligations?

Question 29

Why was the shadow banking system important during the 2007-2009 U.S.financial crisis?

Question 30

Describe the sequence of events in a financial crisis in an advanced economy and explain why they can cause economic activity to decline.

Question 31

Debt deflation refers to the decline in debt values as creditors agree to lower interest rates as an alternative to defaults.

Question 32

Describe how the European debt crisis evolved.

Question 33

The Internet stock market bubble of the late 1990s led to one of the worst financial crises in U.S.history.Banks lost billions of dollars as Internet companies went bankrupt.

Question 34

A financial crisis occurs when information flows in financial markets experience a particularly large disruption.

Question 35

During a bank panic,many banks fail in a very short time period.

Question 36

In Europe,Greece was the first nation to face a debt crisis.

Question 37

Bank failures have been a feature of all U.S.financial crises from 1800 to 1944.

Question 38

An unusual feature of the "Great Recession" in the U.S.from 2007-2009 was that the crisis did not spread to European nations.

Question 39

Explain the relationship between agency theory and a financial crisis.