Economics of Money, Banking, and Financial Markets, 12e, Global Edition (Mishkin)
Chapter 12 Financial Crises in Advanced Economies
12.1 What is a Financial Crisis?
1) A major disruption in financial markets characterized by sharp declines in asset prices and
firm failures is called a
A) financial crisis.
B) fiscal imbalance.
C) free-rider problem.
D) “lemons” problem.
2) A financial crisis occurs when an increase in asymmetric information from a disruption in the
financial system
A) causes severe adverse selection and moral hazard problems that make financial markets
incapable of channeling funds efficiently.
B) allows for a more efficient use of funds.
C) increases economic activity.
D) reduces uncertainty in the economy and increases market efficiency.
3) A serious consequence of a financial crisis is
A) a contraction in economic activity.
B) an increase in asset prices.
C) financial engineering.
D) financial globalization.
4) ________ are asymmetric information problems that act as a barrier to efficient allocation of
capital.
A) Asset prices
B) Credit imbalances
C) Financial frictions
D) Financial derivatives
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12.2 Dynamics of Financial Crises
1) Financial crises in advanced economies might start from a
A) debt deflation.
B) currency crisis.
C) mismanagement of financial innovations.
D) currency mismatch.
2) When financial institutions go on a lending spree and expand their lending at a rapid pace they
are participating in a
A) credit boom.
B) credit bust.
C) deleveraging.
D) market race.
3) When the value of loans begins to drop, the net worth of financial institutions falls causing
them to cut back on lending in a process called
A) deleveraging.
B) releveraging.
C) capitulation.
D) deflation.
4) When financial intermediaries deleverage, firms cannot fund investment opportunities
resulting in
A) a contraction of economic activity.
B) an economic boom.
C) an increased opportunity for growth.
D) a call for government regulation.
5) When asset prices rise above their fundamental economic values, a(n) ________ occurs.
A) asset-price bubble
B) liability war
C) decline in lending
D) decrease in moral hazard
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6) The most frequent causes of financial crisis in advanced economies include, besides a stock
market crash or the failure of a major financial institution, _________.
A) Low interest rates
B) Low asset prices
C) High financial regulation
D) High uncertainty
7) If uncertainty about banks’ health causes depositors to begin to withdraw their funds from
banks, the country experiences a(n)
A) banking crisis.
B) financial recovery.
C) reduction of the adverse selection and moral hazard problems.
D) increase in information available to investors.
8) In a bank panic, the source of contagion is the
A) free-rider problem.
B) too-big-to-fail problem.
C) transactions cost problem.
D) asymmetric information problem.
9) Debt deflation occurs when
A) an economic downturn causes the price level to fall and a deterioration in firms’ net worth
because of the increased burden of indebtedness.
B) rising interest rates worsen adverse selection and moral hazard problems.
C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the
value of collateral.
D) corporations pay back their loans before the scheduled maturity date.
10) A substantial decrease in the aggregate price level that reduces firms’ net worth may stall a
recovery from a recession. This process is called
A) debt deflation.
B) moral hazard.
C) insolvency.
D) illiquidity.
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11) A possible sequence for the three stages of a financial crisis might be ________ leads to
________ leads to ________.
A) asset price declines; banking crises; unanticipated decline in price level
B) unanticipated decline in price level; banking crises; increase in interest rates
C) banking crises; increase in interest rates; unanticipated decline in price level
D) banking crises; increase in uncertainty; increase in interest rates
12) The economy recovers quickly from most recessions, but the increase in adverse selection
and moral hazard problems in the credit markets caused by ________ led to the severe economic
contraction known as The Great Depression.
A) debt deflation
B) illiquidity
C) an improvement in banks’ balance sheets
D) increases in bond prices
13) The ________, the difference between the interest rate on Baa corporate bonds and U.S.
Treasury bonds. rose sharply during the Great Depression.
A) credit boom
B) credit spread
C) adjustable-rate
D) default swap
14) Major financial crises typically include feedback mechanisms by which a failure in one
segment of the financial system leads to failures in other segments. Give an example of such
feedback mechanism during the global contagion of the Great Depression.
12.3 The Global Financial Crisis of 2007-2009
1) ________ is a process of bundling together smaller loans (like mortgages) into standard debt
securities.
A) Securitization
B) Origination
C) Debt deflation
D) Distribution
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2) A ________ pays out cash flows from a collection of assets in different tranches, with the
highest-rated tranch paying out first, while lower ones paid out less if there are losses on the
underlying assets.
A) collateralized debt obligation (CDO)
B) adjustable-rate mortgage
C) negotiable CD
D) discount bond
3) The originate-to-distribute business model has a serious ________ problem since the
mortgage broker has little incentive to make sure that the mortgagee is a good credit risk.
A) principal-agent
B) debt deflation
C) democratization of credit
D) collateralized debt
4) If mortgage brokers do not make a strong effort to evaluate whether the borrower can pay off
a loan, this creates a
A) severe adverse selection problem.
B) decline in mortgage applications.
C) call to deregulate the industry.
D) decrease in the demand for houses.
5) Agency problems in the subprime mortgage market included all of the following EXCEPT
A) homeowners could refinance their houses with larger loans when their homes appreciated in
value.
B) mortgage originators had little incentives to make sure that the mortgagee is a good credit
risk.
C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders
of the securities would be paid back.
D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest.
6) The growth of the subprime mortgage market led to
A) increased demand for houses and helped fuel the boom in housing prices.
B) a decline in the housing industry because of higher default risk.
C) a decrease in home ownership as investors chose other assets over housing.
D) decreased demand for houses as the less credit-worthy borrowers could not obtain residential
mortgages.
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7) When housing prices began to decline after their peak in 2006, many subprime borrowers
found that their mortgages were “underwater.” This meant that
A) the value of the house fell below the amount of the mortgage.
B) the basement flooded since they could not afford to fix the leaky plumbing.
C) the roof leaked during a rainstorm.
D) the amount that they owed on their mortgage was less than the value of their house.
8) If a borrower takes out a $200 million loan in a repo agreement and is asked to post $220
million of mortgage-backed securities as collateral, the “haircut” is
A) 5%.
B) 10%.
C) 20%.
D) 50%.
9) As “haircuts” increased during 2007-2009, financial institutions found that to borrow the same
loan amount now required ________ collateral.
A) less
B) no
C) more
D) default-free
10) Although the subprime mortgage market problem began in the United States, the first
indication of the seriousness of the crisis began in
A) Europe.
B) Australia.
C) China.
D) South America.
11) Which investment bank filed for bankruptcy on September 15, 2008 making it the largest
bankruptcy filing in U.S. history?
A) Lehman Brothers
B) Merrill Lynch
C) Bear Stearns
D) Goldman Sachs
12) The global financial crisis of 2007-2009 not only led to a worldwide recession, but also a
________ in the European nations that use the euro currency.
A) currency devaluation
B) budget surplus
C) sovereign debt crisis
D) tax cut
1) How does the process of financial innovation impact the effectiveness of macroprudential
regulation?
A) With financial innovation and new financial instruments created, legislation increased and
made financial regulation more difficult
B) It may be difficult for regulators to understand how new financial innovations will impact the
overall financial system
C) With constantly changing financial innovations the efficiency of the system is reduced
D) With financial innovation regulators better understand its impact on the financial system and
may prevent a future bank crisis.
2) Which of the following is a short term response?
A) Financial support provided by governments to bail out banks
B) Micro- and macroprudential policies
C) Consumer Protection
D) Strengthening the financial infrastructure of an economy
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12.5 Stabilizing the Global Financial System: Long term Responses
1) Microprudential supervision focuses on the safety and soundness of
A) individual financial institutions.
B) the financial system as a whole.
C) the shadow banking system.
D) government credit agencies.
2) Microprudential supervision does all of the following EXCEPT
A) checking capital ratios of a bank.
B) checking a bank’s compliance with disclosure requirements.
C) assessing the riskiness of an individual bank’s activities.
D) focusing on financial system liquidity.
3) Macroprudential supervision policies try to prevent a leverage cycle by changing capital
requirements so that they ________ during an expansion and ________ during a downturn.
A) increase; decrease
B) increase; increase
C) decrease; increase
D) decrease; decrease
12.6 Future Regulations and Policy Areas at the International Level
1) Well designed macro- and microprudential policies combined with international supervisory
cooperation among central banks and regulators aids in
A) gauging the level of adherence of jurisdictions to regulatory standards
B) helping consumers acquire knowledge and better analyze information
C) plugging all potential loopholes of regulatory arbitrage
D) enhancing global cooperation
2) The following are the main goals of the FSB (Financial Stability Board) EXCEPT
A) To reveal regulatory gaps
B) To monitors markets for asset price bubbles and the buildup of systemic risk
C) To provide policymakers with useful recommendations
D) To harmonize financial regulations among national regulators and international financial
institutions
3) Why is the LIBOR scandal considered one of the most scandalous financial frauds?
A) Various notable banks in London manipulated the LIBOR interest rates to boost their profits.
B) Consumers were unable to unfold the complexity of financial instruments.
C) It made payments to brokers for pushing borrowers into higher priced loans.
D) Took large trading risks