Chapter 17

Question 1

subprime mortgages

Answer 1

Loans to home buyers with too little income or too few assets to qualify for standard (“prime”) mortgages

Question 2

Credit crunch

Answer 2

Either loss of access to credit of find themselves forced to pay drastically higher interest rates

Question 3

financial panic

Answer 3

a sudden and widespread disruption of financial markets

Question 4

Banking crisis

Answer 4

When a significant portion of the banking sector ceases to function

Question 5

matuirity transformation

Answer 5

the transformation of short-term liabilities into long-term assets

Question 6

Shadow banking

Answer 6

The fact that that before the 2008 crisis these financial institutions were neither closely watched nor effectively regulated

Investment banks; hedge funds such as LTCM; money market funds

Question 7

Depository banks

Answer 7

Banks that accept deposits

Commercial banks and savings and loans

Question 8

Maturity transformation

Answer 8

The conversion of short-term liabilities into long-term assets

Question 9

Shadow bank

Answer 9

A nondepository financial institution that engages in maturity transformation

Question 10

Repo market

Answer 10

The overnight credit market

Question 11

Banking crises

Answer 11

Occurs when a large part of the depository banking sector or the shadow banking sector fails or threatens to fail

Question 12

Asset bubble

Answer 12

The price of an asset is pushed to an unreasonably high level due to expectations of further price gains

Question 13

Financial contagion

Answer 13

A vicious downward spiral among depository banks or shadow banks: each bank’s failiure worsens fears and increases the likelihood that another bank will fail

Question 14

Financial panic

Answer 14

A sudden and widespread disruption of the financial markets that occurs when people suddenly lose faith in the liquidity of financial institutions and markets

Question 15

Bank holiday

Answer 15

When Franklin Delano Roosevelt declared a temporary closure of all banks to put an end to the vicious cycle

Question 16

Three main reasons why banking crises normally lead to recessions:

Answer 16

1. Credit crunch arising from reduced availability of credit
2. Financial distress caused by a debt overhang
3. The loss of monetary policy effectiveness

Question 17

Credit crunch

Answer 17

Potential borrowers either can’t get credit at all or must pay very high interest rates

Question 18

Debt overhang

Answer 18

Occurs when a vicious circle of deleveraging leaves a borrower with high debt but diminished assets

Question 19

The FED’s normal response to a recession:

Answer 19

It engages in open-market operations, purchasing short-term government debt from banks

Question 20

Three main kinds of action banks and governments take in an effort to limit the fallout from banking crises:

Answer 20

1. They act as the lender of last resort
2. They offer guarantees to depositors and others with claims on banks
3. An extreme crisis, a central bank will step in and provide financing to private credit markets

Question 21

Lender of last resort

Answer 21

An institution, usually a country’s central bank, that provides funds to financial institutions when they are unable to borrow from the private credit markets

Question 22

When will a lender of last resort not help?

Answer 22

If the public believes that the bank’s assets aren’t worth enough to cover its debts even if it doesn’t have to sell these assets on short notice

Question 23

When governments take on bank’s risk, they often demand a ________________

Answer 23

quid pro quo

they often take ownership of the banks they are rescuing

Question 24

4 main elements of the Wall Street Reform and Consumer Protection Act “Dodd-Frank Bill”

Answer 24

Consumer protection

Derivatives regulation

Regulation of shadow banks

Resolution authority over nonbank financial institutions that face bankruptcy

Question 25

Consumer protection

Dodd frank bill

Answer 25

Creates the Consumer Financial Protection Bureau dedicated to poicing financial industry practices and protecting borrowers

Question 26

Derivatives regulations

Answer 26

Supposed to help spread risk but simply concealed it

Under new law, most derivatives have to be gought and sold in open, transparent markets, limiting the extent financial players can take on risk

Question 27

Regulation of Shadow Banks

Answer 27

Gives a special panel the ability to designate financial institutions as “systemically important” mean that their activities may create a banking crisis

Such institutions will be subject to bank-like regulation of their capital, their investments, and so on

Question 28

Resolution authority

Answer 28

having the legal authority over nonbank financial institutions that face bankruptcy