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

Question 1

The mortgage default rate is

A)the percentage of home mortgage loans in which the borrower has failed to make the current monthly payment.
B)equal to the foreclosure rate.
C)the percentage of home mortgages in which the borrower is 90 days or more late with the payment or it is in the foreclosure process.
D)the percentage of home mortgages in which the borrower owes more than the home is worth.

Answer 1

C

Question 2

Which of the following is most central to the understanding of the economic crisis of 2008?

A)the decline of the stock market in late 2007
B)the housing boom (2001-2005) and bust (2007-2008)
C)the sharp rise in oil prices in 2008
D)unethical investment practices beginning in 2000

Answer 2

B

Question 3

During 1979-2005, the mortgage default rate

A)was less than the foreclosure rate.
B)soared to more than 5 percent during recessions but declined sharply during economic expansions.
C)soared to more than 5 percent during expansions but declined sharply during economic recessions.
D)was generally between 1 and 2 percent.

Answer 3

D

Question 4

After a period of price stability in the 1990s, housing prices increased dramatically during 2002-2005 because

A)regulations designed to make housing more affordable increased the demand for housing and drove housing prices upward.
B)regulations designed to make housing more affordable decreased the number of sub-prime loans and made home buying a safer investment.
C)mortgage lending standards tightened, and therefore mortgage loans for housing were only available to buyers purchasing highly expensive homes.
D)home buyers were putting more money down and requiring more return on their investment, driving housing prices up.

Question 5

During the 1980s and 1990s, the Federal Reserve's monetary policy focused primarily on

A)keeping short-term interest rates low in order to stimulate real output and economic growth.
B)a variety of factors, such as unemployment and real GDP, resulting in variable inflation rates throughout this period.
C)keeping inflation low and the general price level relatively stable.
D)monetary expansion in order to reduce unemployment.

Question 6

Based on the rising housing prices of 2000-2005, many buyers opted for interest-only loans and variable rate mortgages with little or no down payment because

A)they expected short-term interest rates to fall substantially in the future and this would reduce their monthly mortgage payment in the years ahead.
B)variable rate mortgages are a good way to reduce the risk accompanying your investment when you plan to stay in the house for a long time.
C)they thought housing prices would continue to rise and therefore they would be able to sell the house for a profit within a couple of years.
D)they could easily recoup their investment, even if there was a downturn in housing prices in the future.

Question 7

Many investment banks quickly collapsed when the housing market collapsed because

A)the Federal Reserve was unwilling to provide them with short-term loans.
B)they ignored the risk assigned by the rating agencies, resulting in leverage ratios that were too low.
C)new regulations required investment banks to maintain more capital against their residential housing loans than was true for commercial business loans.
D)they were highly leveraged and had little reserves on hand to meet the short-term debt obligations of the mortgage-backed securities.

Question 8

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused

A)housing prices to fall during that period.
B)a reduction in the use of adjustable rate mortgages to finance the purchase of housing.
C)a reduction in housing construction during 2002-2005.
D)mal-investment, that is, excessive investment in housing construction during 2002-2005.

Question 9

Since 1995, federal regulations have

A)tightened mortgage lending standards and therefore made it difficult to obtain a loan to purchase a house.
B)increased the down payment housing buyers are required to make in order to obtain a mortgage loan.
C)loosened lending standards and made it possible for many buyers to purchase a house with little or no down payment.
D)required investment banks to maintain more capital against their holdings of mortgage loans.

Question 10

Which of the following was the result of Fannie Mae and Freddie Mac being both privately-owned and government-sponsored enterprises?

A)Their government sponsorship increased their cost of acquiring loanable funds.
B)They were unable to earn profits and pay dividends to their shareholders.
C)Congressional regulations exerted little or no impact on their business operations.
D)Their activities were more susceptible to political influence and favoritism.

Question 11

What was the original stated purpose of Fannie Mae and Freddie Mac?

A)to allow the government to extend loans directly to low-income and minority households
B)to help provide liquidity in the secondary mortgage markets
C)to operate as non-profit entities that would provide competition for for-profit mortgage companies
D)to take on mortgages going into default in order to prevent them from going into foreclosure

Question 12

Between 2001 and 2005, sub-prime (including Atl-A) mortgages ____________ as a share of the total.

A)fell from 30 percent to less than 10 percent
B)rose from 5 percent to 10 percent
C)rose from 10 percent to more than 30 percent
D)fell from more than 20 percent to less than 10 percent

Question 13

A sub-prime loan is a loan extended to borrowers

A)at a subsidized interest rate below the prime rate normally offered to the most creditworthy borrowers.
B)with blemished credit or limited documentation of their income, employment history, and other indicators of credit worthiness.
C)seeking a 30-year, fixed rate mortgage.
D)who have a FICO score above 660.

Question 14

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused

A)an increase in demand for housing and higher housing prices.
B)an increase in demand for housing and lower housing prices.
C)a reduction in demand for housing and higher housing prices.
D)a reduction in demand for housing and lower housing prices.

Question 15

An analysis of housing prices between 1987 and 2008 indicates that prices

A)increased sharply in the five years leading up to the housing bust in 2007.
B)were relatively stable before dropping sharply in 2001.
C)rose steadily during the 1990s, but declined sharply beginning in 2001.
D)were erratic, but there was no discernable trend during either the 1990s or 2000-2006.

Question 16

Fannie Mae and Freddie Mac's rapid increase in the percentage of all mortgages held encouraged mortgage lenders to

A)tighten credit standards and decrease the number of sub-prime loans extended to borrowers.
B)offer lower rates than what Fannie Mae and Freddie Mac could offer.
C)lower credit standards and offer terms acceptable to Fannie Mae and Freddie Mac.
D)scrutinize the credit-worthiness of borrowers and require higher down payments on mortgages.

Question 17

Fannie Mae and Freddie Mac's dominance of the secondary mortgage market during 1995-2008 encouraged mortgage originators to

A)extend only 30-year, fixed-rate mortgages.
B)require higher down payments in order to obtain a home mortgage.
C)loosen lending standards as long as the mortgages were acceptable to Fannie Mae and Freddie Mac.
D)scrutinize the credit-worthiness of borrowers more carefully.

Question 18

In 2008-2009, which of the following weakened the demand stimulus effects of expansionary fiscal policy?

A)the unwillingness of the federal government to run budget deficits
B)the heavy indebtedness of American households
C)a high level of household spending on big-ticket items such as houses and cars, which do not promote economic growth
D)the continuation of the high saving rates on the part of Americans

Question 19

Which of the following contributed to the soaring housing prices during 2002-2004?

A)the Fed's high-interest rate policy
B)the tightening of loan standards by commercial lenders
C)the increasing popularity of fixed-rate, long-term loans to lock in low interest rates
D)the Fed's low-interest rate policy

Question 20

As short-term interest rates began to rise in 2005, which one of the following mortgage loan categories experienced the largest increase in default and foreclosure rates?

A)fixed rate mortgages to prime borrowers
B)fixed rate mortgages to sub-prime borrowers
C)adjustable rate mortgages extended to both prime and sub-prime borrowers
D)adjustable rate mortgages to sub-prime borrowers only; the default and foreclosure rates of these loans extended to prime borrowers declined

Question 21

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

Question 22

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.

Question 23

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.

Question 24

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.

Question 25

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

Question 26

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.

Question 27

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.

Question 28

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.

Question 29

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.

Question 30

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.

Question 31

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.

Question 32

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.

Question 33

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.

Question 34

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.

Question 35

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.

Question 36

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.

Question 37

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.

Question 38

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.

Question 39

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

Question 40

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

Question 41

Beginning in 2002, Federal Reserve policy

A)switched its focus from price stability to stimulating real GDP and reducing unemployment.
B)kept interest rates artificially high, driving housing prices upward.
C)kept interest rates artificially low, driving housing prices downward.
D)switched its focus from stimulating real GDP and reducing unemployment to price stability.

Question 42

Which of the following is an example of how incentive structures contributed to the collapse of investment banks?

A)The bonus structure of most executives was tied to long-term profitability.
B)The ratings agencies were paid attractive fees by investment banks seeking high ratings for their securities.
C)Mortgage-backed securities were closely scrutinized in order to minimize risk and obtain higher ratings.
D)Despite SEC regulations, investment banks kept leverage ratios low in order to increase profits.

Question 43

Since the mid-1990s, the percentage of new mortgages categorized as sub-prime or Alt-A loans has

A)remained steady at about 5 percent of all loans.
B)decreased to about one third of all loans, while conventional loans have increased to about two-thirds.
C)increased to about one third of all loans, while conventional loans have decreased to about one third as well.
D)decreased as a result of regulations designed to tighten loan standards.

Question 44

The mortgage-backed securities issued by investment banks caused many investment banks to fail when

A)stock prices declined by approximately 40 percent in 2008.
B)housing prices increased rapidly beginning in 2002.
C)federal regulators required investment banks to maintain more capital against their residential housing loans than was true for commercial business loans.
D)the default rates of the mortgages financed by the securities increased sharply.

Question 45

When housing prices fell during 2007, the mortgage default rate

A)declined as well.
B)responded in a similar manner as during other recent recessions.
C)increased substantially.
D)changed very little.

Question 46

The 1995 modifications to the Community Reinvestment Act

A)imposed numeric goals for loans extended to low-income and minority groups that were difficult for many banks to meet without reducing loan standards.
B)reduced the incentive of banks to extend loans to low-income and minority groups.
C)encouraged low-income and minority housing purchasers to make larger down payments so they would have more equity in their houses.
D)made it more difficult for low-income and minority groups to obtain conventional loans.

Question 47

Which of the following contributed to the soaring housing prices during 2002-2005?

A)the Fed's low-interest rate policy
B)regulations that reduced the required down payment and other lending standards for home mortgages
C)the increased leverage lending by Fannie Mae, Freddie Mac, and large investment banks
D)all of the above

Question 48

Are new regulations likely to prevent a future financial crisis?

A)Yes, regulatory agencies have been effective at anticipating the secondary effects of new regulations.
B)Yes, industries that were highly regulated were unaffected by the Crisis of 2008.
C)No, regulators have a poor record with regard to foreseeing future problems.
D)No, current regulations could have prevented the Crisis of 2008, but were largely ignored.

Question 49

The primary objective of the monetary policy of the Fed should be

A)low rates of unemployment.
B)the growth rate of real GDP.
C)the achievement of price stability.
D)the regulation of financial institutions.

Question 50

During 2006-2008, the housing foreclosure rate rose sharply

A)for fixed interest rate loans, but it was virtually unchanged for adjustable rate loans.
B)for adjustable rate loans to both sub-prime and prime borrowers, but there was little change in the foreclosure rate on fixed interest rate loans.
C)for adjustable rate loans to sub-prime borrowers, but the foreclosure rate on these loans to prime borrowers was virtually unchanged.
D)for adjustable rate loans to prime borrowers, but the foreclosure rate on these loans to sub-prime borrowers was virtually unchanged.

Question 51

Compared to the 1970s and early 1980s, household debt as a share of income in 2007 has

A)increased at a steady rate over time.
B)remained about the same.
C)more than doubled.
D)decreased slowly over time.

Question 52

An SEC rule change allowing investment banks to increase the leverage of their investment capital prompted many investment banks to

A)increase the amount of assets held in relation to mortgage-backed securities being issued.
B)decrease the amount of assets held in relation to mortgage-backed securities being issued.
C)decrease the amount of mortgage-backed securities being offered.
D)reduce the ratio of mortgage loans to equity capital of the investment bank.

Question 53

In the latter half of the 1990s, the Department of Housing and Urban Development imposed regulations on Fannie Mae and Freddie Mac, requiring them to

A)extend more mortgage loans to households with low and moderate incomes.
B)accept only mortgages with at least a 20 percent down payment.
C)tighten lending standards and increase their holdings of low-risk, conventional mortgages.
D)extend more mortgage loans to households with middle and high incomes.

Question 54

Fannie Mae and Freddie Mac held a competitive advantage over other mortgage lenders primarily because

A)they were established as non-profit entities and thus did not need to show that they were profitable.
B)they could borrow funds cheaper than other lenders because their bonds were perceived to be backed by the federal government.
C)they were allowed to institute higher loan standards than other banks and mortgage lenders.
D)they were exempt from federal regulations monitoring lending practices.

Question 55

The secondary mortgage market is the market

A)designated specifically for prime and other low risk mortgages.
B)designated specifically for sub-prime and other high risk mortgages.
C)where mortgages originated by a lender are sold to another financial institution.
D)where home purchasers borrow funds from mortgage originators.

Question 56

When expansionary monetary policy pushes interest rates to artificially low levels,

A)the demand for and prices of interest-sensitive goods, like housing, will increase.
B)people will delay their purchases of interest-sensitive goods, like housing, into the future.
C)the demand for interest-sensitive goods, like housing, will increase, but their prices will decline.
D)the demand for and prices of interest-sensitive goods, like housing, will decline.

Question 57

The Fed's low short-term interest rate policy of 2002 to 2004 made it highly attractive for buyers to purchase a house

A)with a large down payment and a 30-year, fixed rate mortgage.
B)with a large down payment and an adjustable rate mortgage.
C)with a small down payment and an adjustable rate mortgage.
D)quickly before housing prices began to decline in 2006.

Question 58

Which of the following makes it difficult for monetary policy-makers to institute policy changes in a manner that will promote economic stability?

A)Monetary policy-makers do not have sufficient tools to alter the supply of money.
B)The time lags between changes in monetary policy and when the changes exert an impact on output and prices are long and variable.
C)Monetary policy is unable to alter short-term interest rates.
D)Even though monetary policy can alter interest rates, there is little evidence that interest rates influence the demand for and prices of housing.

Question 59

Which of the following resulted from Fed policy that first kept short-term interest rates extremely low during 2002-2004, and then pushed them up substantially during 2005-2006?

A)a reduction in housing prices because variable rate mortgages were unattractive throughout this period
B)upward pressure on housing prices when the interest rates were low, but downward pressure on the price of housing as the interest rates rose
C)lower default rates on adjustable rate mortgages as the interest rates peaked during 2006
D)downward pressure on housing prices when the interest rates were low, but upward pressure on the price of housing as the interest rates rose

Question 60

When interest payments on home mortgages and home equity loans are tax deductible,

A)households will keep other forms of debt separate from their home mortgage.
B)households will shift other forms of debt to their home mortgage.
C)households are likely to increase the amount of equity in their home.
D)the overall amount of household debt is likely to decrease in relation to household income.

Question 61

Which of the following is an example of how incentive structures contributed to the collapse of investment banks?

A)The bonus structures of most executives were tied to short-term profitability.
B)The rating agencies acted independently in assigning ratings to mortgage-backed securities and had no incentive to understate the risks.
C)Mortgage-backed securities were closely scrutinized in order to minimize risk and obtain higher ratings.
D)Despite SEC regulations, investment banks kept leverage ratios low in order to increase profits.

Question 62

Which of the following accurately describes the relationship between mortgage default rates and the 2008 recession?

A)The recession of 2008 triggered the initial increase in the mortgage default rate.
B)The rise in the mortgage default rate preceded the recession and it was a major cause of the 2008 economic downturn.
C)Both the increase in the mortgage default rate and the economic recession were the result of the stock market crash of 2008.
D)The rise in the mortgage default rate and the economic recession were separate issues and there was no relationship between the two.

Question 63

The substantial increase in household debt relative to income since the mid 1980s meant that in 2008 many households

A)had little savings or other reserve assets for use to deal with unexpected expenditures.
B)could safely afford to purchase larger homes because housing is always a good investment.
C)could spend everything they earned because their interest obligations on outstanding credit were low.
D)would be able to easily adjust their current spending if their monthly payments on adjustable rate mortgages rose.

Question 64

The bundling of mortgages together and the issuing of securities for their financing made it possible for investment banks to

A)reduce their exposure to risk in the event that the overall mortgage default rate rose.
B)reduce the amount of capital required to back these bundled securities.
C)build up large reserves so they would be able to meet their obligations even if the mortgage default rate rose substantially.
D)quickly access funds to meet short-term debt obligations.