Chapter 8- Credit Markets

Question 1

interest rate

Answer 1

Savers (lenders) are paid for delaying
consumption until the future, by borrowers, who wish to consume or invest more in the present and will
later pay for that privilege

Question 2

direct finance

Answer 2

a borrower deals directly with the lender: Businesses and
governments who “sell bonds” to consumers, businesses, and governments, also are engaging in direct
finance

Question 3

maturity

Answer 3

Someone buys the bond, then can redeem the bond at a later date.
The date that the payment will be made to the lender is called maturity

Question 4

face value

Answer 4

The value paid at maturity

Question 5

zero coupon bond

Answer 5

no interest payments are made on the bond

Question 6

coupon rate

Answer 6

interest rate quoted on a bond (Many corporate bonds also make interest payments twice per year until maturity)

Question 7

indirect finance

Answer 7

When individuals and businesses use middlemen, such as banks, for borrowing and lending

Question 8

financial intermediaries such as banks (advantages over direct lenders) :

Answer 8

1. Spread the risk of nonpayment
2. comparative advantage in credit evaluation and collection
3. divide denominations of loans
4. match time preferences

Question 9

usury law

Answer 9

puts a price ceiling on interest rates: would cause a shortage in the market if the ceiling was
below the equilibrium interest rate

Question 10

public saves more

Answer 10

supply of loanable funds increase, interest rates decrease

Question 11

if people view future as being bright

Answer 11

demand for loanable funds increases, which raises interest rates and amount saved/borrowed

Question 12

government borrowing =

Answer 12

increased demand for loanable funds

Question 13

indirect crowding out

Answer 13

When an increase in government spending is financed through borrowing, private spending decreases due to rising interest rates

Question 14

direct crowding out

Answer 14

when government spends, private markets spend less because their ability to spend is taxed away (Bastiat’s main thing)

Question 15

leveraged buyout

Answer 15

a firm borrows in order to purchase another firm, then immediately sells the firm in whole or in parts

Question 16

insolvent

Answer 16

a firm who owes more than it owns (includes assets)

Question 17

illiquid

Answer 17

firm that can’t pay its immediate obligations (can be illiquid without being insolvent)

Question 18

bankruptcy

Answer 18

When firms cannot pay their obligations and cannot borrow more to pay, they may declare bankruptcy

Question 19

bankruptcy and economic health

Answer 19

contributes to economic health by moving resources to more productive uses, creating value: facilities would not disappear with a bankruptcy and neither would
all the jobs

Question 20

absolute priority rule

Answer 20

rule courts are supposed to follow that says: creditors are ranked with regard
to how long ago the company became indebted to them, then every penny is paid to the “senior” debt,
before any less senior debt is paid. Then every penny is paid to the next senior debt class, and so on. The
stockholders—the owners—are last on the list (was not followed in General Motors example)

Question 21

Community Reinvestment Act of 1977

Answer 21

made banks give loans to poor people (who couldn’t get home loans before because they couldn’t pay)

Question 22

US Department of Housing and Urban Development in the early/mid 1990s

Answer 22

directed FMs to purchase loans that banks made to risky borrowers

Question 23

nonconforming loans

Answer 23

loans that banks made to risky borrowers who could not meet the old standards for housing loans

Question 24

Federal Reserve in the early 2000s (money supply and interest rates)

Answer 24

greatly increased the money supply, lowering interest rates, fueling even more home loans

Question 25

when housing prices fell due to inflation caused by Fed increasing money supply:

Answer 25

homes that were repossessed from borrowers who couldn’t pay could no longer be sold for a profit on the market

Question 26

TARP: Troubled Asset Relief Program

Answer 26

The bailouts were orchestrated by the president of the New York Federal Reserve Bank, Timothy Geithner,
alongside Federal Reserve Chairman Ben Bernanke, and Secretary of the Treasury Hank Paulson. During
this time, they collaborated on a proposal that congress hand them $700 billion to buy all the bad mortgage
backed bonds

Question 27

What did Paulson do with TARP funds?

Answer 27

handed (forced) the billions of dollars to banks instead of buying bad bonds

Question 28

Dodd-Frank Bill of 2010 (proposed remedy to 2008 housing collapse)

Answer 28

• created new government regulatory agencies,
• created new regulations, and
• directed regulators to write additional regulations.

Question 29

Established the Financial Stability Oversight Council

Answer 29

Dodd-Frank: headed by the Secretary of the Treasury, that is supposed to identify systemic risks—risks to the entire financial system. The chairman of the Fed, a
major cause of systemic risk in the early 2000s, is a member of the FSOC. FSOC can designate financial
institutions as “too big to fail”—Systemically Important Financial Institutions (SIFIs), guaranteeing
that they will be bailed out if needed, causing the market to pour more money into them. In addition, if
the FSOC actually breaks up financial institutions, the regulators, themselves, may be introducing huge
systemic risks because regulators who have outlandish authority can make outlandish mistakes

Question 30

Instituted bailout insurance

Answer 30

Dodd-Frank: financial institutions pay into an insurance pool. If a major financial failure occurs, the insurance pays the cost

Question 31

Created the Consumer Financial Protection Bureau to regulate consumer credit

Answer 31

A major early
target of the CFPB is the credit market for the poor—pawn shops and payday loan companies. Since
the poor are risky borrowers, forcing companies that serve them to act as if they are serving the middle
class and rich is ending the legal credit market that the poor use, driving them to loan sharks. The
CFPB is nearly beyond control by elected representatives. It receives its funding through the Fed,
independent of congress. Only its head, designated by the president, must be approved by the senate

Question 32

normal unemployment

Answer 32

4% - 5.5%

Question 33

unemployment high:

Answer 33

10% during the recession

Question 34

unemployment in September 2014

Answer 34

5.9 %

Question 35

current unemployment

Answer 35

4.9%

Question 36

systematic risks

Answer 36

risks to the entire financial system

Question 37

SIFIs (Systemically Important Financial Institutions)

Answer 37

designated as ‘too big to fail’ by Financial Stability Oversight Council (FSOC)

Question 38

Why was unemployment duration longer in this recession?

Answer 38

unemployment benefits extended from 26 to 99 weeks

Question 39

economic growth

Answer 39

increased production of goods and services