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Financial Markets and Institutions, 8e (Mishkin) Chapter 8 Why Do Financial Crises Occur and Why Are They So Damaging to the Economy? 1) Financial crises  are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.  occur when adverse selection and moral hazard problems in financial markets become more significant.  frequently lead to sharp contractions in economic activity. 2) 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.  none of the above. 3) In an advanced economy, a financial crisis can begin in several ways, including  mismanagement of financial liberalization or innovation.  asset pricing booms and busts.  an increase in uncertainty caused by failure of financial institutions. 4) What is a credit boom?  Essentially a lending spree on the part of banks and other financial institutions 5) The process of deleveraging refers to  cutbacks in lending by financial institutions. 6) When asset prices fall following a boom,  moral hazard may increase in companies that have lost net worth in the bust.  financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging. 7) During the 1800s, many U.S. financial crises were precipitated by an increase in ________, often originating in London.  interest rates 8) Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.  banking 9) Stage Three of a financial crisis in an advanced economy features  debt deflation. 10) Debt deflation refers to  a decline in net worth as price levels fall while debt burden remains unchanged. 11) Factors that lead to worsening conditions in financial markets include  increases in interest rates.  declining stock prices.  increasing uncertainty in financial markets. 12) Factors that lead to worsening conditions in financial markets include  bank panics. 13) Most financial crises in the United States have begun with  a steep stock market decline.  an increase in uncertainty resulting from the failure of a major firm. 14) 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.  increasing; decreasing 15) Adverse selection and moral hazard problems increased in magnitude during the early years 1 Copyright © 2015 Pearson Education Inc

of the Great Depression as  stock prices declined to 10 percent of their levels in 1929.  banks failed.  the aggregate price level declined. 16) Stock market declines preceded a full-blown financial crisis  in the United States in 1929. 17) Which of the following factors led up to the Greece debt crisis in 2009-2010?  A decline in tax revenues resulting from a contraction in economic activity  A double-digit budget deficit 18) What is a collateralized debt obligation?  A tranche of an SPV that has been setup based on default risk 19) Which of the following led to the U.S. financial crisis of 2007-2009?  Financial innovation in mortgage markets  Agency problems in mortgage markets 20) Approximately how large was the U.S. subprime mortgage market in 2007?  $1 trillion 21) When we refer to the shadow banking system, what are we talking about?  Hedge funds, investment banks, and other nonbank financial firms that supply liquidity 22) The impact of the 2007-2009 financial crisis was widespread, including  the first major bank failure in the UK in over 100 years.  the failure of Bear Stearns, the fifth-largest U.S. investment bank.  the bailout of Fannie Mae and Freddie Mac by the U.S. Treasury. 1) A financial crisis occurs when information flows in financial markets experience a particularly large disruption. * TRUE 2) Factors that can lead to worsening conditions in financial markets include increasing interest rates and asset price booms. * TRUE 3) During a bank panic, many banks fail in a very short time period. * TRUE 4) 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. * FALSE 5) Bank failures have been a feature of all U.S. financial crises from 1800 to 1944. * TRUE 6) Debt deflation refers to the decline in debt values as creditors agree to lower interest rates as an alternative to defaults. * FALSE 7) 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. * FALSE 8) An unusual feature of the "Great Recession" in the U.S. from 2007-2009 was that the crisis did not spread to European nations. * FALSE 9) In Europe, Greece was the first nation to face a debt crisis. * TRUE

8.3 Essay

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1) Explain the relationship between agency theory and a financial crisis. Topic: Chapter 8.1 What Is a Financial Crisis? 2) Describe the sequence of events in a financial crisis in an advanced economy and explain why they can cause economic activity to decline. Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 3) What is the problem with government safety nets, such as deposit insurance, during the formative stages of a financial crisis? Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 4) Discuss why some view the Fed as a culprit in the U.S. housing bubble during the 2000s. Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 5) Describe a special purpose vehicle. How are they related to the creation of collateralized debt obligations? Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 6) Discuss some of the financial innovations in mortgage markets that led to the U.S. financial crisis in 2007. Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 7) Why was the shadow banking system important during the 2007-2009 U.S. financial crisis? Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies 8) Describe how the European debt crisis evolved. Topic: Chapter 8.2 Dynamics of Financial Crises in Advanced Economies

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