Queens College, CUNY - ECON 201

CHAPTER 10: The Great Recession: A First Look

MULTIPLE CHOICE

1)The Great Recession began in                     and ended in              .

1. 1. December 2007; June 2009                    d. June 2007; December 2009
   2. December 2008; June 2010                    e.   June 2007; June 2009
   3. May 2008; March 2010

2. Which of the following financial institutions converted to bank holding companies in the financial collapse?
   1. Wells Fargo
   2. Goldman Sachs
   3. the National Bureau of Economic Holdings
   4. Citicorp
   5. the Federal Reserve

3. During the Great Recession, the unemployment rate peaked at      percent. a. 12.1                                                              d. 25.8

b.   9.5                                                           e.   6.7

c.                                10

4. What declined during the Great Recession?
   1. the unemployment rate                          d. the size of the Fed’s portfolio
   2. the median duration of unemployment e.   world GDP
   3. the federal government deficit

5. When was the deepest recession since the end of World War II?

6. Federal debt as a ratio to GDP            between 2007 and 2012, from            percent to             

percent.

1. 1. doubled; 36; 72                                       d. doubled; 80; 160
   2. tripled; 27; 81                                         e.   tripled; 10; 30
   3. fell; 82; 41

7. In                , housing prices collapsed following a decade of rapid increase. a.   2009                                                        d. 2008

b.   1995                                                        e.   2001

c.                                2006

8. Between the middle of 2006 and the first quarter of 2012, the national index for the U.S. housing market:
   1. declined by about 10.1 percent.             d. was flat.
   2. declined by about 42 percent.                e.   grew at the rate of inflation.
   3. increased by about 33 percent.

9. The housing bubble was NOT fueled by which of the following factors:
   1. loosening lending standards.                  d.   subprime lending.
   2. high unemployment.                               e.   demand pressures.
   3. low interest rates.

10. Which country did NOT experience a financial crisis in the 1990s?
    1. Mexico                                                    d. India
    2. Russia                                                      e.   Argentina
    3. Brazil

11. The global savings glut can be defined as:
    1. the increase in foreign savings moving into the United States in search of investment opportunities.
    2. the rapid increase in personal saving rates in the United States leading to increased lending to foreign countries.
    3. the response of U.S. savings to low interest rates in the early 2000s.
    4. the decline in saving rates globally.
    5. the precautionary savings increase in response to the establishment of the euro.

12. A recent financial crisis occurred in:
    1. Mexico in 1994.                                      d. China in 1994.
    2. India in 1972.                                          e.   Norway in 2000.
    3. Russia in 2005.

13. What is the Federal Funds rate?

1. 1. the interest rate charged by banks to their best customers
   2. the ideal inflation rate
   3. the interest rate charged by banks for overnight loans
   4. the interest rate suggested by the Taylor rule
   5. the sustainable level of federal budget deficit

14. The name given to low-quality loans is:
    1. fixed-income loans.                                d. subprime loans.
    2. opportunity loans.                                   e.   “sucker loans.”
    3. ARM 7/1.

15. According to The Economist, by 2006            of new home loans were            loans.
    1. one-half; ARM one-third                         d. almost all; inflation-indexed
    2. one-fifth; subprime                                 e.   three-fourths; subprime
    3. only 1 percent; traditional 30-year-fixed

16. Between May 2004 and May 2006, the Federal Reserve        its interest rate            .
    1. raised; from 1.25 percent to 5.25 percent
    2. lowered; from 5.25 percent to 0 percent
    3. kept; fixed at 3.25 percent
    4. lowered; from 6.5 percent to 1 percent
    5. The Fed does not control interest rates.

17. What incentive did banks have to give large loans to households with relatively little income?
    1. rapidly rising housing prices                   d. high unemployment rates
    2. low interest rates                                    e.   government guarantees
    3. high rates of inflation

18. Securitization is defined as:
    1. bolstering defense spending.
    2. making it more difficult to enter the United States illegally.
    3. creating incentives for firms to protect proprietary information.
    4. disallowing the use of collateral for loans.
    5. lumping large numbers of financial instruments together and selling pieces to different types of investors.

19. Which of the following is NOT a securitized asset?
    1. mortgage-backed securities                   d. commercial bonds

1. 2. asset-backed commercial paper            e.   CDOs
   3. collateralized debt obligations

20. Which investment bank collapsed in September 2008?
    1. Merrill Lynch                                          d. Wells Fargo
    2. Goldman Sachs                                       e.   Barclays
    3. Lehman Brothers

21. The goal of securitization is to:
    1. lock a constant rate of return for up to 10 years.
    2. ensure one financial institution holds all the risk.
    3. diversify risk by buying different classes of assets.
    4. sell paper to Fannie Mae and/or Freddie Mac.
    5. earn high returns for investors.

22. What is an indicator of the extent of risk in financial systems?
    1. the difference between the unemployment rate and the natural rate of unemployment
    2. falling commodity prices
    3. the spread between the monthly U.S. T-bill yield and LIBOR rate
    4. the spread between inflation-indexed and nonindexed U.S. bonds
    5. the number of banks applying for federal assistance

23. In                , the Fed began to raise the federal funds rate in response to    .
    1. mid-2004; rising inflation
    2. mid-2008; a bubble in stock markets
    3. mid-2007; the decline in housing prices
    4. mid-2000; rising unemployment rates
    5. early 2009; rising inflation

24. Which of the following financial institutions was taken over by the federal government?
    1. Freddie Mac                                            d. Merrill Lynch
    2. Bank of America                                     e.   Fifth Third Bank
    3. Lehman Brothers

25. A supposition of mortgage securitization is that:
    1. mortgages can be swapped for T-bills.
    2. the federal government guarantees all loans.
    3. all the mortgages were “high quality.”

1. 4. the underlying assets are rated AAA.
   5. a large fraction of loans will not go bad at the same time.

26. The majority of mortgage-backed securities were held by:
    1. large commercial and investment banks.
    2. the Fed.
    3. the federal government.
    4. large teacher pension funds.
    5. money market mutual funds.

27. The acronym “CDO” stands for:
    1. constant deficit obligation.                     d. corporate deposit opportunities.
    2. collateralized debt obligation.                e.   capital default ownership.
    3. congressional debt organization.

28. The acronym “TARP” stands for:
    1. Total Assistance for Retired Persons.     d. Treasury Asset Risk Persistence.
    2. Tax and Revenue Program.                    e.   Total Asset Rate Possibility.
    3. Troubled Asset Relief Program.

29. The “flight to safety” in the fall of 2007 led investors to        , which led to              .
    1. buy BAA rated corporate bonds; a decline in stock prices
    2. buy T-bills; a rise in the spread between LIBOR rates and T-bill yields
    3. purchase stocks; a sharp increase in the S&P 500
    4. oil futures; a spike in natural gas prices
    5. buy foreign exchanges; a rapid appreciation of the euro

30. In mid-2008 oil prices:
    1. stayed constant.                                      d. rose to $140 per barrel.
    2. rose by 40 percent.                                 e.   rose to $70 per barrel.
    3. fell to $30 per barrel.

31. Part of the rapid increase in oil prices was due to:
    1. declining demand in OECD countries.
    2. falling supplies from OPEC countries.
    3. lower inflation expectations in the United States.
    4. the financial meltdown.
    5. increasing demand in China.

32. In addition to oil price increases in 2008:
    1. natural gas prices fell.                            d. inflation remained unchanged.
    2. the interest rate premium fell.              e.   aggregate supply increased.
    3. commodity prices also rose.

33. In contrast to the dot-com stock market bubble, the bursting of the housing bubble  , implying

               .

1. 1. affected almost every financial institution; the risk was well diversified
   2. affected a small number of investors; the risk was not well diversified
   3. hurt every household; households paid too high an interest rate
   4. was attenuated by a quick response by the Fed; the Fed’s policy was effective
   5. increased household expenditures; it had little effect on the macroeconomy

34. The increased spread between three-month LIBOR and three-month bond yields led to  . This is a classic example of                   .
    1. reduced lending; a liquidity crisis
    2. a rush to buy bonds; an asset bubble
    3. falling risk in financial markets; risk sharing
    4. increased inflationary expectations; cost-push inflation
    5. increased consumer expenditure; the monetary transmission mechanism

35. The spread between three-month LIBOR and three-month bond yields      of/at             

percent after             .

1. 1. rose to a high; 1.0; the collapse of Merrill Lynch
   2. fell to a low; 0.0; the Fed opened the discount window to investment banks
   3. rose to a high; 10; the S&P 500 index fell by 250 points
   4. rose to a high; 3.5; the collapse of Lehman Brothers
   5. remained unchanged; 2.0; the rescue of Fannie Mae and Freddie Mac

36. The                was hastily designed to             in September 2008.
    1. Troubled Asset Relief Program; prevent financial collapse
    2. American Recovery and Reinvestment Act; prevent fiscal collapse
    3. New Deal; prevent tax revenues from falling
    4. Savings and Loan bank bailout; prevent declining mortgage applications
    5. Sherman Antitrust Act; reduce commercial banks’ power over financial markets

37. After the Fed began to raise the federal funds rate in 2004:

1. 1. investors quickly sold U.S. treasuries.
   2. default on subprime mortgages increased.
   3. inflation picked up steam.
   4. housing prices recovered and grew, but more slowly than in the previous 10 years.
   5. stock markets retreated and fell to all-time lows.

38.                 peaked at the end of            . By February 2010,              .
    1. Total nonfarm employment; 2007; over 8 million jobs were lost
    2. The unemployment rate; 2006; inflation was 0 percent
    3. Median weeks of unemployment; 2007; the unemployment rate had fallen to 7 percent
    4. Aggregate weekly hours; 2007; inflation was negative
    5. The inflation rate; 2008; the unemployment rate had risen to 11 percent

39. Short-run output              in the last quarter of 2008 and           by the middle of 2009.
    1. growth was flat; recovered to a modest 1.2 percent
    2. was positive; fell to ?3 percent
    3. turned negative; bottomed out at below ?7 percent
    4. equaled zero; fell to ?2 percent
    5. was rising; unemployment was 8 percent

40. In the middle of 2009,             ; by February 2010,             .
    1. over 8 million jobs were lost; short-run output bottomed out at over ?6 percent
    2. short-run output bottomed out at below ?7 percent; over 8 million jobs were lost
    3. inflation was 5 percent; the unemployment rate was 12 percent
    4. the federal funds rate was 5 percent; it had fallen to 1 percent
    5. unemployment fell to 8 percent; home sales were rising steadily

41. From a low of                percent in 2007, the unemployment rate rose to        percent by 2010. a. 10; 25                                                           d. 4.4; 10

b.   58; 63                                                      e.   7; 12

c.                                0; 7

The following table shows real GDP and potential real GDP for the years 2005–2015. Refer to this table when answering the following questions.

Table 10.1 ($ billions)

(Source: Federal Reserve Economic Data, St. Louis Federal Reserve)

42. During which year was the economy in an expansionary gap? a.   2001                                                        d. 2003

b.   2004                                                        e.   none of the above

c.                                2002

43. About how much did short-run output fluctuations equal in 2005 and 2009, respectively?
    1. ?0.3 percent; ?2.4 percent                            d. 86.1 percent; 83.8 percent
    2. 0.22 percent; ?6.4 percent                            e.   Not enough information is given.
    3. ?33 percent; 323.1 percent

44. About how much did short-run output equal in 2009 and 2015, respectively?
    1. ?6.4 percent; ?2.0 percent                            d. 106.9 percent; 102.1 percent
    2. 6.9 percent; 2.1 percent                         e.   Not enough information is given.
    3. 93.6 percent; 98.0 percent

45. When was the recession deepest?

a.   2005                                                        d. 2008

b.   2007                                                        e.   Not enough information is given.

c.                                2009

46. The average decline in GDP growth for all recessions since 1950 is       percent, but for the Great Recession it was             percent.

a.   2.1; 6.1                                                    d... 1.7; 4.7

b.   0.4; 31.4                                                  e.   0; 2.2

c................................ 3.7; 1.7

47. In a typical recession, generally only           expenditure rises.

48. In terms of loss of employment, which recession in the post–World War II period saw the greatest losses?

a.   2007–2009                                              d.   1973–1975

b.   1981–1982                                              e.   1953–1954

c.                                2001

49. The sharp swing in core inflation in 2008–2009 was due to:
    1. movements in energy prices.
    2. the sharp decline in housing prices.
    3. There was no sharp swing in core inflation.
    4. rapid increases in wages.
    5. rapidly rising unemployment.

50. Which of the following countries did the financial crisis affect?
    1. the United States                                    d. France
    2. Germany                                                 e.   All of these answers are correct.
    3. Japan

51. According to the IMF, which of these countries experienced positive growth in 2009?
    1. India                                                        d. Italy
    2. the United States                                    e.   Brazil
    3. the United Kingdom

52. According to the IMF, which of these countries experienced negative growth in 2015, six years after the crisis?
    1. India                                                        d. Italy
    2. the United States                                    e.   Brazil
    3. the United Kingdom

53. IMF studies conducted after the financial crisis projected negative growth in:
    1. Italy.                                                        d.   China.
    2. Japan.                                                      e.   Brazil.
    3. the United Kingdom.

54. One of the key differences between the United States and the European euro area countries in the aftermath of the Great Recession is that:
    1. U.S. inflation and unemployment are both about 4 percent, and in Europe, they are about 8 percent.
    2. GDP growth in the United States is negative, but European growth rates are higher than normal.
    3. inflation in the United States is negative, while Europe has extremely high inflation rates.
    4. the U.S. unemployment rate has largely returned to prerecession levels, whereas European unemployment is still above prerecession levels.
    5. interest rates in the United States have risen sharply, while those in the euro area are negative.

55. Which of the following is/are NOT (an) asset(s) on a bank’s balance sheet?

Refer to the following table when answering the following questions.

Table 10.2: Hypothetical Bank Sheet ($ millions)

56. Column A is bank               and Column B is bank              .
    1. assets; liabilities
    2. liabilities; assets
    3. on-balance sheet activity; off-balance sheet activity
    4. “shadow” activity; “open air” activity
    5. Not enough information is given.

57. The bank’s net worth is equal to:

a.   $3,400.                                                    d. ?$700.

b. ?$2,000.                                                   e.   Not enough information is given.

c.                                $2,000.

58. The bank’s assets are equal to            and liabilities are             . a. $9,600; $11,600                                           d. $11,600; $9,600

b. ?$2,000; $2,000                                          e.   Not enough information is given.

c.                                $6,800; $7,500

59. The bank’s assets are equal to:

a.   $9,000.                                                    d. ?$700.

b.   $2,000.                                                    e.   Not enough information is given.

c.                                $11,600.

60. This bank’s liabilities are equal to:

a.   $9,600.                                                    d. $700.

b.   $11,600.                                                  e.   $3,400.

c.                                ?$2,000.

61. If reserve requirements are 3 percent and capital requirements are 10 percent, the bank meets:
    1. reserve requirements but not capital requirements.
    2. neither reserve requirements nor capital requirements.
    3. both reserve and capital requirements.
    4. capital requirements but not reserve requirements.
    5. Not enough information is given.

62. What is the approximate leverage ratio of this bank?

a.   4.80                                                         d. 0.83

b.   1.21                                                         e.   Not enough information is given.

c.                                5.80

63. If the value of this bank’s investments decreases by $1,000, what is the bank’s equity? a.                                                       $1,000    d. $2,400

b.   $3,900                                                     e.   Not enough information is given.

c.                                $3,100

64. If the value of this bank’s investments decreases by $1,000, what is the approximate leverage ratio of this bank?

a.   9.60                                                         d. 2.78

2. 3.87                                                         e.   Not enough information is given.

c.                                8.60

65. What is the industry Mr. McGuire advises Benjamin to enter after college in the movie The Graduate?
    1. microchips                                              d. plastics
    2. genetic engineering                                e.   import-export
    3. leverage

66. When a bank’s assets cannot cover its liabilities, the bank is:
    1. illiquid.                                                    d. bought out by its shareholders.
    2. nationalized.                                           e.   insolvent.
    3. immediately shut down.

67. When the investment bank Bear Stearns collapsed, its leverage ratio was: a.                                                            2 to 1.    d. 16 to 1.

b.   35 to 1.                                                   e.   1 to 12.

3. 8 to 1.

68. A significant cause of the 2008 financial crisis was that financial institutions were:
    1. unfunded.                                                d. nationalized.
    2. overleveraged.                                        e.   illiquid.
    3. already insolvent.

69. Net worth is equal to a bank’s:
    1. investments minus deposits.                   d. loans minus capital.
    2. cash plus reserves.                                  e.   total assets minus total liabilities.
    3. deposits plus loans.

70. When all depositors converge on a bank to remove their deposits there is a(n):
    1. bank run.                                                 d. financial meltdown.
    2. bank panic.                                              e.   insolvency.
    3. liquidity crisis.

71. The Federal Deposit Insurance Corporation was established, in part, to:
    1. prevent bank runs.
    2. make loans to insolvent banks.
    3. increase confidence in investment banks.
    4. eradicate bank risk altogether.
    5. underwrite consumer loans.

72. In what year was the Federal Deposit Insurance Corporation established? a.   2007                                                        d. 1991

b.   1933                                                        e.   1983

c.                                1945

73. In 1933, the               was set up to              .
    1. Troubled Asset Relief Fund; shore up insolvent commercial banks
    2. Federal Reserve System; centralize monetary policy
    3. Federal Deposit Insurance Corporation; help prevent bank runs
    4. Depository Institutions Deregulation and Monetary Control Act; repeal the Glass-Steagall Act
    5. U.S. Department of Treasury; monitor investment bank activity

74. In 1933, the               was established to prevent bank runs; in 2008,         was set up to increase liquidity in financial markets.
    1. Troubled Asset Relief Fund; AIG
    2. Federal Deposit Insurance Corporation; the Troubled Asset Relief Fund
    3. U.S. Department of Treasury; the Comptroller of the Currency
    4. Federal Reserve System; the Federal Deposit Insurance Corporation
    5. Depository Institutions Deregulation and Monetary Control Act; the Glass-Steagall Act

75. In the recent financial crisis, the banks’ problems arose from:
    1. bank runs.
    2. revaluation of loans.
    3. a rapid loss of reserves.
    4. the riskiness of 30-year-fixed mortgages.
    5. lending money in return for short-term debt.

76. In the months following the collapse of Lehman Brothers, banks became increasingly worried about:
    1. rising real estate prices.                         d. spikes in the federal funds rate.
    2. lending money via commercial paper.   e.   exchange rate volatility.
    3. the rapid loss of reserves.

77. When a bank experiences a bank run, it may have to:
    1. print money to cover deposits.               d. call in its loans.
    2. pay a higher insurance premium.          e.   increase its reserves.
    3. offer depositors an IOU.

78. In the last months of 2008 following the collapse of        , interest rates on commercial paper

                and access to this form of liquidity           .

1. 1. Lehman Brothers; rose by over 5 percent; contracted
   2. Washington Mutual; fell by over 3 percent; expanded
   3. Merrill Lynch; rose by 5 percent; stayed constant
   4. General Motors; rose by over 3 percent; contracted
   5. AIG; stayed constant; remained unchanged

The following figure shows the daily three-month treasury yield in September 2008. Refer to the following figure when answering the following questions.

(Source: Federal Reserve Economic Data, St. Louis Federal Reserve)

79. Consider the data in Figure 10.1. What does the data for mid-September in this figure suggest?
    1. Increasing investor confidence in the effectiveness of TARP led to smaller purchases of

U.S. treasuries.

1. 2. There was a rapid movement of assets from treasuries to stocks.
   3. In the aftermath of the collapse of Lehman Brothers, investors fled to the safety of short- term treasuries.
   4. Prices of gold declined in line with short-term treasury yields.
   5. General Motors and Chrysler declared bankruptcy.

80. Consider the data in Figure 10.1. What event precipitated the change in the yield in mid-September?
    1. the expanded trade deficit with China   d. the Greek fiscal crisis
    2. the election of Barack Obama               e.   the continuing Japanese recession
    3. the bankruptcy of Lehman Brothers

TRUE/FALSE

1. India did not suffer significantly from the financial crisis in 2007–2009.

2. The federal funds rate is the rate the Fed charges to member banks.

3. The home price index of housing prices dropped about 10 percent when the housing bubble burst.

4. Between 1996 and 2006, housing prices averaged about 10 percent annual growth per year.

5. During the 1990s and early 2000s, a number of developing countries suffered from financial crises. This led to an increase in investment in these countries.

6. The savings glut in the early and mid-2000s led to an increase in U.S. interest rates, which spurred a stock market bubble.

7. Subprime loans are loans made to households that do not necessarily meet “standard” lending restrictions.

8. Between May 2004 and May 2006, the Fed raised the federal funds rate by 4 percentage points due to rising inflation worries.

9. According to The Economist, in 2006, approximately one-half of all home loans were subprime.

10. By August 2007, almost 16 percent of all subprime loans were in default.

11. The basic principle of securitization is that bundling a variety of different types of loans into a new asset and selling pieces of that asset to many investors will diversify risk.

12. In September 2008, the government took control of Lehman Brothers, and Fannie Mae and Freddie Mac were sold to Bank of America.

13. A salve to the wounds of the financial crisis was the rapid decline of oil prices in 2008.

14. The longest recessionary gap in the post–World War II period was the 1982–1983 recession.

15. In the trough of the Great Recession, real GDP was about 5 percent below potential real GDP.

16. Unemployment in the Great Recession peaked at 10 percent.

17. During the Great Recession, inflation was relatively stable because energy and other commodity prices were stable.

18. In 2009, China and India both experienced positive economic growth, while the rest of Asia, Europe, and the United States experienced negative economic growth.

19. Loans, investments, and cash are on the asset side of a bank’s balance sheet.

20. Bank leverage is equal to a bank’s assets minus its liabilities.

21. When depositors rush to get their deposits out of a single bank, it is called a bank panic.

SHORT ANSWER

1. Briefly discuss the macroeconomic outcomes of the financial crisis.

2. Explain the relationships between the global savings glut, subprime loans, interest rates, and the burst housing bubble.

3. Figure 10.2 shows the U.S. housing price index (solid line, left axis) and one-year adjustable mortgage rates (dashed line, right axis). In the context of the housing and financial crisis, discuss the relationship between these two series.

Figure 10.2: Housing Prices and One –Year Adjustable Mortgage Rates

(Source: Federal Reserve Economic II, St. Louis Federal Reserve)

4. Figure 10.3 shows the weekly U.S. three-month bond yield from January 2013 to May 2016. What is the cause of the rise in the three-month yield in late 2015?

5. How does “securitizing” assets reduce overall risk?

6. Briefly compare the impact of the Great Recession and financial crises to other U.S. recessions since 1950.

(Source: Federal Reserve Economic II, St. Louis Federal Reserve)