Question 1

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

Accepted Answer

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. 
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 2

Which of the following was a contributing factor to the housing boom and bust and the financial crisis of 2008?

Accepted Answer

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. 
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 3

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

Accepted Answer

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. 
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.

Question 4

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

Accepted Answer

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. 
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 5

The secondary mortgage market is the market

Accepted Answer

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. 
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 6

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

Accepted Answer

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. 
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 7

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

Accepted Answer

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. 
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 8

Beginning in 2002, Federal Reserve policy

Accepted Answer

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. 
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 9

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to

Accepted Answer

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. 
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 10

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

Accepted Answer

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. 
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 11

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

Accepted Answer

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 
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 12

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

Accepted Answer

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. 
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 13

Many investment banks quickly collapsed when the housing market collapsed because

Accepted Answer

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. 
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 14

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?

Accepted Answer

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. 
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 15

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

Accepted Answer

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. 
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 16

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

Accepted Answer

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. 
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 17

The strong demand for housing, rising housing prices, and a construction boom from 2000 to 2005 were a result of

Accepted Answer

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. 
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 18

The 1995 modifications to the Community Reinvestment Act

Accepted Answer

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. 
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 19

When housing prices fell during 2007, the mortgage default rate

Accepted Answer

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

Question 20

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?

Accepted Answer

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 
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

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

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

Which of the following was a contributing factor to the housing boom and bust and the financial crisis of 2008?

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

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

The secondary mortgage market is the market

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

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

Beginning in 2002, Federal Reserve policy

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to

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

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

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

Many investment banks quickly collapsed when the housing market collapsed because

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?

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

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

The strong demand for housing, rising housing prices, and a construction boom from 2000 to 2005 were a result of

The 1995 modifications to the Community Reinvestment Act

When housing prices fell during 2007, the mortgage default rate

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?

The Economic Approach

A: Some Tools of the Economist

B: Some Tools of the Economist

A: Supply, Demand, and the Market Process

B: Supply, Demand, and the Market Process

A: Supply and Demand: Applications and Extensions

B: Supply and Demand: Applications and Extensions

Difficult Cases for the Market and the Role of Government

The Economics of Collective Decision-Making

Consumer Choice and Elasticity

A: Costs and the Supply of Goods

B: Costs and the Supply of Goods

A: Price Takers and the Competitive Process

B: Price Takers and the Competitive Process

Price-Searcher Markets With Low Entry Barriers

A: Price-Searcher Markets With High Entry Barriers

B: Price-Searcher Markets With High Entry Barriers

The Supply of and Demand for Productive Resources

Earnings, Productivity, and the Job Market

Investment, the Capital Market, and the Wealth of Nations

Income Inequality and Poverty

Appendix: Government Spending and Taxation

Appendix: the Economics of Social Security

Appendix: the Stock Market: Its Function, Performance, and Potential As an Investment Opportunity

Appendix: Great Debates in Economics: Keynes Versus Hayek

Appendix: Lessons From the Great Depression

Appendix: the Economics of Healthcare

Appendix:education: Problems and Performance

Appendix: Earnings Differences Between Men and Women

Appendix: the Question of Resource Exhaustion

Appendix: Do Labor Unions Increase the Wages of Workers

Appendix: Difficult Environmental Cases and the Role of Government

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