The 2008 Financial Crisis and Government Response

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Questions and Answers

Which of the following is a factor that mitigates the problem of bank runs?

Fractional reserve system

Deposit insurance

Lender of last resort (correct)

Bank regulation

Why do you think banks are one of the most-regulated industries in the US?

To prevent bank runs

To protect consumer deposits (correct)

To increase profitability

To ensure fair competition

Which event prompted the creation of the FDIC in 1933?

Bank runs between 1929 and 1933 (correct)

Northern Rock crisis

Lebanon crisis in 2021

Asian Financial Crisis

Which of the following is NOT a key idea in the theory of bank runs?

Bank runs are always related to bank fundamentals Signup and view all the answers

In equilibrium 1 of the theory of bank runs, what do impatient depositors do?

Withdraw at t=1 Signup and view all the answers

What is the role of the Federal Reserve as the 'lender of last resort'?

To prevent bank runs and address bank illiquidity Signup and view all the answers

What is the purpose of the Federal Deposit Insurance Corporation (FDIC)?

To provide deposit insurance for banks Signup and view all the answers

Which type of mutual fund tries to outperform a stock index and typically has relatively high fees?

Active mutual funds Signup and view all the answers

Which government program injected capital into the financial sector by purchasing preferred shares in banks and other financial institutions?

Capital Purchase Program Signup and view all the answers

What is the purpose of the Morningstar Style Box in classifying active mutual funds?

To determine appropriate benchmark for a fund Signup and view all the answers

What was the total investment made by the US Treasury in the Capital Purchase Program?

$200 billion Signup and view all the answers

What is the main advantage of ETFs (Exchange-Traded Funds) compared to mutual funds?

Ability to trade throughout the day Signup and view all the answers

Which government program provided loans and capital injections to automakers GM and Chrysler?

Auto bailout Signup and view all the answers

What are hedge funds primarily invested in?

A variety of assets Signup and view all the answers

What is the formula for calculating the Net Asset Value (NAV) per share of an investment company?

NAV = (Value of Assets - Value of Liabilities) / Number of Shares Signup and view all the answers

According to the text, why do renters with insurance have weaker incentives to protect against theft?

Because they believe their belongings are fully covered in case of theft Signup and view all the answers

What does TBTF stand for?

Too Big to Fail Signup and view all the answers

Why does TBTF create a moral hazard problem?

Because it incentivizes banks to take excessive risks Signup and view all the answers

What are the origins of TBTF?

The size and complexity of certain banks Signup and view all the answers

Which of the following is a potential risk associated with hedge fund strategies?

Hedge funds may generate fake alpha by betting against extreme risks Signup and view all the answers

What is the main purpose of activism in hedge fund strategies?

To increase firm value by pushing for changes in the company Signup and view all the answers

What is the key characteristic of global macro hedge fund strategies?

Speculating on changes in the value of currencies and interest rates Signup and view all the answers

What is the main purpose of arbitrage in hedge fund strategies?

To take advantage of differing prices for the same asset Signup and view all the answers

Study Notes

Bank Runs and Regulation

Factors mitigating bank runs include effective communication, deposit insurance, and a stable banking environment.
Banks are heavily regulated in the US due to their role in the economy, risks to financial stability, and need to protect consumers' deposits.

Creation of the FDIC

The Federal Deposit Insurance Corporation (FDIC) was created in response to widespread bank failures during the Great Depression in 1933.

Theory of Bank Runs

A key idea NOT in the theory of bank runs is the absence of depositors' panic.
In equilibrium 1 of the theory, impatient depositors withdraw their funds first, which can trigger a bank run.

Federal Reserve's Role

The Federal Reserve acts as the 'lender of last resort' by providing emergency funds to banks in financial distress to maintain stability in the banking system.

Purpose of the FDIC

The FDIC's primary purpose is to insure deposits, ensuring that depositors do not lose their savings in case of bank failures.

Mutual Funds

Actively managed mutual funds aim to outperform a stock index and generally charge higher fees compared to passive funds.
The Morningstar Style Box helps classify active mutual funds based on their investment style and market capitalization.

Government Economic Programs

The Capital Purchase Program involved a significant investment from the US Treasury to inject capital into financial institutions following the 2008 financial crisis.
The program allocated $205 billion in preferred shares to stabilize the financial sector.
The Auto Industry Financing Program provided loans and capital to automakers General Motors and Chrysler during economic downturns.

Investment Vehicles

Hedge funds are primarily invested in alternative assets such as stocks, bonds, derivatives, and commodities.
The Net Asset Value (NAV) per share is calculated by subtracting total liabilities from total assets and dividing by the number of outstanding shares.

Risk and Incentives

Renters with insurance may have weaker incentives to protect against theft due to the safety net that insurance provides.
TBTF (Too Big to Fail) refers to institutions whose failure would significantly impact the economy, prompting government intervention.

Moral Hazard and TBTF

TBTF creates a moral hazard problem as it encourages risky behavior knowing that the government may bail out failing institutions.
The origins of TBTF stem from historical financial crises where certain banks received government support to avoid economic collapse.

Hedge Fund Strategies

Potential risks associated with hedge fund strategies include high leverage, illiquidity, and lack of transparency.
Activism in hedge fund strategies aims to influence company management and operations for improved performance.
Global macro hedge fund strategies focus on broad economic trends and typically invest across various asset classes.
Arbitrage in hedge fund strategies is employed to exploit price discrepancies in different markets to achieve profits.

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Description

Test your knowledge of the 2008 financial crisis and the government's response with this quiz. Learn about the leaked bailout plans, the temporary ban on short selling, the rejection and eventual passing of TARP, and more. See how much you know about the policies implemented and the broad goals of the government during this turbulent time in the economy.