When the value of loans begins to drop, the net

by | Aug 20, 2025 | Business

Question 1

  1. 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
    deleveraging.
    capitulation.
    deflation.
    releveraging.

3.22581 points

Question 2

  1. A sharp decline in the stock market means that the ________ of corporations has fallen making lenders ________ willing to lend.
    liability; less
    net worth; more
    net worth; less
    liability; more

3.22581 points

Question 3

  1. A credit boom can lead to a(n) ________ such as we saw in the tech stock market in the late 1990s.
    decrease in moral hazard
    decline in lending
    liability war
    asset-price bubble

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Question 4

  1. A sharp stock market decline increases moral hazard incentives
    reducing uncertainty in the economy and increasing market efficiency.
    since lenders are more willing to make loans.
    since borrowing firms have less to lose if their investments fail.
    because it is immoral to profit from someone’s loss.

3.22581 points

Question 5

  1. A serious consequence of a financial crisis is
    an increase in asset prices.
    financial globalization.
    a contraction in economic activity.
    financial engineering.

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Question 6

  1. Continental Bank of Illinois was bailed out before a banking crisis occurred. Regulators thought that Continental was too big to fail.

    True

    False

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Question 7

  1. In a bank panic, the source of contagion is the
    transactions cost problem.
    too-big-to-fail problem.
    free-rider problem.
    asymmetric information problem.

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Question 8

  1. We learn from Gorton’s book that Ben Bernanke had no idea that the collapse of Lehman Brothers would disrupt the financial markets.

    True

    False

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Question 9

  1. When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in
    an increased opportunity for growth.
    a contraction of economic activity.
    a call for government regulation.
    an economic boom.

3.22581 points

Question 10

  1. 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.
    democratization of credit
    principal-agent
    debt deflation
    collateralized debt

3.22581 points

Question 11

  1. We learn from Gorton that it is not possible to prove that had Lehman Brothers been bailed out by the government or the Federal Reserve the financial crisis of 2008 would not have occurred. This is an example of not being able to prove the “counterfactual”.

    True

    False

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Question 12

  1. According to Gorton; The limited liability of shareholders in a business creates moral hazard because owners can take risks that can benefit them at the potential expense of creditors.

    True

    False

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Question 13

  1. A bank panic can lead to a severe contraction in economic activity due to
    a decline in international trade.
    the losses of bank shareholders.
    a decline in lending for productive investment.
    the losses of bank depositors.

3.22581 points

Question 14

  1. Factors that lead to worsening conditions in financial markets include:
    declining interest rates.
    the deterioration in banks’ balance sheets.
    increases in bond prices.
    unanticipated increases in the price level.

3.22581 points

Question 15

  1. ________ is a process of bundling together smaller loans (like mortgages) into standard debt securities.
    Debt deflation
    Distribution
    Origination
    Securitization

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Question 16

  1. A ________ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities.
    Negotiable CD
    Collateralized debt obligation (CDO)
    Discount bond
    Adjustable-rate mortgage

3.22581 points

Question 17

  1. An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms’ assets. The result is
    an increase in the real net worth of the borrowing firm.
    that net worth in real terms declines.
    an increase in lending.
    that adverse selection and moral hazard problems are reduced.

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Question 18

  1. Gorton argues that it is not more capital that is needed to prevent bank failures but more cash and liquidity.

    True

    False

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Question 19

  1. The growth of the subprime mortgage market led to
    increased demand for houses and helped fuel the boom in housing prices.
    decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages.
    a decrease in home ownership as investors chose other assets over housing.
    a decline in the housing industry because of higher default risk.

3.22581 points

Question 20

  1. Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a
    call to deregulate the industry.
    severe adverse selection problem.
    decrease in the demand for houses.
    decline in mortgage applications.

3.22581 points

Question 21

  1. Paul Volcker argued that the failure of Continental Illinois Bank would have caused other banks to face runs.

    True

    False

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Question 22

  1. A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a
    financial crisis.
    fiscal imbalance.
    free-rider problem.
    “lemons” problem.

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Question 23

  1. The bankruptcy of Lehman Brothers “paralyzed the interbank market, where short term borrowing and lending froze”.

    True

    False

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Question 24

  1. When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a
    deleveraging.
    credit boom.
    credit bust.
    market race.

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Question 25

  1. A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system
    causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently.
    reduces uncertainty in the economy and increases market efficiency.
    increases economic activity.
    allows for a more efficient use of funds.

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Question 26

  1. Banks are subject to runs when the collateral backing their liabilities are subject to market risks and the value of the liabilities reflects these risks.

    True

    False

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Question 27

  1. A possible sequence for the three stages of a financial crisis in the U.S. might be ________ leads to ________ leads to ________.
    unanticipated decline in price level; banking crises; increase in interest rates
    asset price declines; banking crises; unanticipated decline in price level
    banking crises; increase in uncertainty; increase in interest rates
    banking crises; increase in interest rates; unanticipated decline in price level

3.22581 points

Question 28

  1. The FDIC has never extended protection to uninsured general creditors because this would create increased moral hazard in the banking system.

    True

    False

3.22581 points

Question 29

  1. Debt deflation occurs when
    rising interest rates worsen adverse selection and moral hazard problems.
    an economic downturn causes the price level to fall and a deterioration in firms’ net worth because of the increased burden of indebtedness.
    lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral.
    corporations pay back their loans before the scheduled maturity date.

3.22581 points

Question 30

  1. Over time banks have become more efficient at using bank capital and thus use less of it relative to the assets they fund. The capital ratios in 2009 of US banks were lower than they were in the 1980s and 1990s.

    True

    False

3.22581 points

Question 31

  1. Gorton argues that regulating capital ratios cannot prevent a systemic run on banks.

    True

    False

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