Chapter 8 Notes

Question 1

What is direct finance? Give an example.

Answer 1

A saver lends directly to a borrower. A bond or a loan to a friend is direct finance.

Question 2

What is the face value and maturity of a bond?

Answer 2

Face value is how much the borrower is paid at redemption. Maturity is the date of redemption.

Question 3

Why would anyone buy a bond that did not make interest payments?

Answer 3

Since they buy the bond for less than the face value, they are paid back more than they paid, so the interest rate is implied.

Question 4

What is indirect finance?

Answer 4

Savers lend to borrowers using intermediaries, such as banks

Question 5

In what ways do banks add value in the economy?

Answer 5

They spread the risk of nonpayment, divide denominations, match time horizons, and specialize in evaluation of creditworthiness and collection.

Question 6

Why do the supply and demand for loanable funds have their shapes?

Answer 6

People are willing to save more at higher interest rates, but willing to borrow less higher interest rates

Question 7

What is a usury law? What is its effect?

Answer 7

A price ceiling on interest rates. They cause shortages of loanable funds.

Question 8

Why are the interest rates on credit cards high, compared to other loans?

Answer 8

They are unsecured and require great administrative costs due to expanding and contracting as borrowers charge more and pay down.

Question 9

If the public decides to save less, what happens to the supply and/or demand for funds? What happens to the interest rate?

Answer 9

The supply of loanable funds falls. The interest rate rises.

Question 10

If people decide to borrow more, what happens to the supply and/or demand for loanable funds? What happens to the interest rate?

Answer 10

The demand for loanable funds rises, causing the interest rate to rise.

Question 11

Besides savers, which other group can affect the supply of loanable funds?

Answer 11

The Federal Reserve

Question 12

What is the difference between funds supplied by savers and funds supplies by the Fed?

Answer 12

When savers delay consumption, they can eventually spend those savings on the increased consumption created by the investments their savings fuel. But with the Fed money creation, there is no reservoir of savings to later consume the increased production, so bubbles are formed.

Question 13

What was the intent of the Community Reinvestment Act?

Answer 13

To encourage banks to make loans to poor people

Question 14

What is the relationship between the Department of Housing and Urban Development and Fannie Mae?

Answer 14

HUD directed Fannie Mae to purchase nonconforming loans.

Question 15

What was the Fed’s role in the housing crisis of the 2000s?

Answer 15

In the early 2000s the Fed increased the money supply, keeping interest rates low, resulting in an expansion of lending.

Question 16

Why didn’t Fannie Mae care if homeowners defaulted when home prices were rising?

Answer 16

Foreclosed homes could sell for more than their purchase price.

Question 17

How did private lenders attempt to compete with Fannie Mae’s implicit government guarantee that their debt would be honored?

Answer 17

By buying insurance on privately issued market mortgage backed bonds from AIG insurance.

Question 18

What is TARP? What was it intended to do?

Answer 18

The Troubled Asset Relief Program was $700B, intended to buy bad mortgage backed bonds.

Question 19

What was done with TARP funds?

Answer 19

They were handed to banks and other financial institutions, as well as to auto companies.

Question 20

How does the Dodd-Frank bill restrict Fannie Mae and Freddie Mac?

Answer 20

The bill does not mention them at all.

Question 21

What is the job of the Financial Stability Oversight Council? Who are its most important members?

Answer 21

To identify risks to the entire financial system and resolve them. The US Treasury Secretary & the Fed Chairman

Question 22

When the FSOC identifies a financial institution as a SIFI–too big to fail–what happens to that institution’s ability to acquire funds?

Answer 22

With a government bailout guarantee the “too big to fail” firm grows bigger.

Question 23

What is the effect of bailout insurance on banks and other financial institutions?

Answer 23

Due to insurance, they will take more risks.

Question 24

What was the unemployment rate in July 2013?

Answer 24

7.4%

Question 25

What is a major cause for unemployment duration during the recovery from the 2009 recession?

Answer 25

Unemployment benefits were extended from 26 weeks to 99 weeks.

Question 26

How long was the average unemployed person out of work? How did this compare to the previous high (since the Great Depression)?

Answer 26

36 weeks. About twice the previous high, since the Great Depression.

Question 27

What were high growth rates during the 1980s recovery? What were the high growth rates in the recovery from the 2009 recession?

Answer 27

For the 1980s, 8%. For the latter, 4%.

Question 28

What has happened to the money supply since the recession? Why?

Answer 28

It has grown rapidly due to the Fed “printing money”

Question 29

True, false, explain: Excess reserves in the banking system are nearly 10 times their traditional level.

Answer 29

False. They are nearly 1000 times their traditional level.

Question 30

Why are excess reserves so high?

Answer 30

Because the Fed began paying interest on reserves