Chapter 17 Flashcards
subprime mortgages
Loans to home buyers with too little income or too few assets to qualify for standard (“prime”) mortgages
Credit crunch
Either loss of access to credit of find themselves forced to pay drastically higher interest rates
financial panic
a sudden and widespread disruption of financial markets
Banking crisis
When a significant portion of the banking sector ceases to function
matuirity transformation
the transformation of short-term liabilities into long-term assets
Shadow banking
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
Depository banks
Banks that accept deposits
Commercial banks and savings and loans
Maturity transformation
The conversion of short-term liabilities into long-term assets
Shadow bank
A nondepository financial institution that engages in maturity transformation
Repo market
The overnight credit market
Banking crises
Occurs when a large part of the depository banking sector or the shadow banking sector fails or threatens to fail
Asset bubble
The price of an asset is pushed to an unreasonably high level due to expectations of further price gains
Financial contagion
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
Financial panic
A sudden and widespread disruption of the financial markets that occurs when people suddenly lose faith in the liquidity of financial institutions and markets
Bank holiday
When Franklin Delano Roosevelt declared a temporary closure of all banks to put an end to the vicious cycle
Three main reasons why banking crises normally lead to recessions:
- Credit crunch arising from reduced availability of credit
- Financial distress caused by a debt overhang
- The loss of monetary policy effectiveness
Credit crunch
Potential borrowers either can’t get credit at all or must pay very high interest rates
Debt overhang
Occurs when a vicious circle of deleveraging leaves a borrower with high debt but diminished assets
The FED’s normal response to a recession:
It engages in open-market operations, purchasing short-term government debt from banks
Three main kinds of action banks and governments take in an effort to limit the fallout from banking crises:
- They act as the lender of last resort
- They offer guarantees to depositors and others with claims on banks
- An extreme crisis, a central bank will step in and provide financing to private credit markets
Lender of last resort
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
When will a lender of last resort not help?
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
When governments take on bank’s risk, they often demand a ________________
quid pro quo
they often take ownership of the banks they are rescuing
4 main elements of the Wall Street Reform and Consumer Protection Act “Dodd-Frank Bill”
Consumer protection
Derivatives regulation
Regulation of shadow banks
Resolution authority over nonbank financial institutions that face bankruptcy
Consumer protection
Dodd frank bill
Creates the Consumer Financial Protection Bureau dedicated to poicing financial industry practices and protecting borrowers
Derivatives regulations
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
Regulation of Shadow Banks
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
Resolution authority
having the legal authority over nonbank financial institutions that face bankruptcy
