Financial Crises

Question 1

Definition of Financial crisis

Answer 1

• It is major disruption of the financial system, typically involving sharp drops in asset prices and failures of financial institutions

Question 2

Mention types of financial crises?

Answer 2

1. Asset-Price Declines
2. Insolvencies
3. Liquidity Crises

Question 3

Explain a crises duo to an Asset-Price Declines:

Answer 3

• A crisis may be triggered by large decreases in the prices of stocks, real estate, or other assets
• Many economists interpret these decreases as the ends of asset-price bubbles

People expectation that the price continous to rise

Causes high demand for the assets

expectations of higher prices self-fulfilling

people begin to worry that asset prices are too high

start selling the assets

crisis begin

Question 4

Explain the role of insolvency in a crisis :

Answer 4

• In a typical crisis, decreases in asset prices are accompanied by failures of financial institutions
• An institution may fail because it becomes insolvent, that is, its assets fall below its liabilities and its net worth (capital) becomes negative
• A commercial bank can become insolvent because of loan defaults, increases in interest rates, and other events.

Question 5

what is liquidity crisis ?

Answer 5

• A bank can fail because it doesn’t have enough liquid assets to make payments it has promised (bank runs)
• Liquidity crises can spread from one financial institution to another largely for psychological reasons

Question 6

A General map a Financial crises:

Answer 6

Question 7

Definition of Too big to fail (TBTF)

Answer 7

• A doctrine that large financial institutions facing failure must be rescued to protect the financial system

Question 8

Cost of Financial Giveaway by the central bank in a crisis?

Answer 8

• The first is the direct costs of payments from the government. These costs are ultimately borne by taxpayers.
• • The worsening of moral hazard, the problem that financial institutions may misuse the funds they raise.

Question 9

Defintion of Equity injection:

Answer 9

• purchases of a financial institution’s stock by the government

Question 10

The U.S. Financial Crisis and Its Aftermath (graph)

(1 part)

Answer 10

Question 11

The U.S. Financial Crisis and Its Aftermath (graph) (2 part)

Answer 11

Question 12

The Money-Market Crisis, Fall 2008 (graph)

Answer 12

Question 13

what was the TARP? (2008 crisis)

Answer 13

Troubled Asset Relief Program (TARP)

The TARP committed $700 billion of government funds to rescue financial institutions.

Question 14

What new Federal Reserve Programs appears during the crisis? and actions?

Answer 14

• the Money Market Investor Funding Facility (MMIFF)

addressed the disruption of the commercial paper market after the run on money-market funds

the Fed lent money to banks that agreed to purchase commercial paper from money-market funds.

• Term Asset-Backed Loan Facility (TALF)

the Fed lent to financial institutions such as hedge funds to finance purchases of securities backed by bank loans

• the Fed began purchasing prime mortgage- backed securities issued by Fannie Mae and Freddie Mac

Question 15

Financial Reform Proposals (graph)

Answer 15

Question 16

Definition of Liquidity trap

Answer 16

• A situation in which output is below potential at a nominal interest rate of zero (a real interest rate of -􏰅p )
• It eliminate the central bank’s usual ability to raise output and inflation; also, zero-bound problem

Question 17

why the Fed took the risk of leading to collaterals of uncertain value? (2008 crisis) (AIG)

Answer 17

• by agreeing to accept some of the potential losses from the financial crisis, the Fed hoped to prevent these losses from occurring.

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• This strategy was similar to the l_ogic of deposit insurance_: by agreeing to bear the costs of a harmful event (bank runs), the government makes the event less likely.

Question 18

what financial reform happens in 2010? (U.S)

Answer 18

• The Financial Services Oversight Council coordinates financial regulation
• A new Office of Credit Ratings examines rating agencies annually and publishes reports on their performance.
• The FDIC gains authority to take over and close a nonbank financial institution if its troubles create systemic risk
• incentivize the separation banks and securities firms
• Issuers of certain risky securities must retain at least 5 percent of the default risk on such securities.

Question 19

what causes of Capital Flight ?

Answer 19

1. Government debt
2. Political risk
3. Banking problems

Question 20

what is the definition of Contagion?

Answer 20

• spread of capital flight from one country to others