Financial Crisis

A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system

• causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently.

• allows for a more efficient use of funds.

• increases economic activity.

• reduces uncertainty in the economy and increases market efficiency.

________ are asymmetric information problems that act as a barrier to efficient allocation of capital.

• Asset prices

• Credit imbalances

• Financial frictions

• Financial derivatives

When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a

• credit boom.

• credit bust.

• deleveraging.

• market race.

When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in

• a contraction of economic activity.

• an economic boom.

• an increased opportunity for growth.

• a call for government regulation.

Most U.S. financial crises have started during periods of ________ either after the start of a recession, a stock market crash, or the failure of a major financial institution.

• low interest rates

• high uncertainty

• low asset prices

• high financial regulation

In a bank panic, the source of contagion is the

• free-rider problem.

• too-big-to-fail problem.

• transactions cost problem.

• asymmetric information problem.

A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called

• debt deflation.

• moral hazard.

• insolvency.

• illiquidity.

A ________ pays out cash flows from a collection of assets in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there are losses on the underlying assets.

• adjustable-rate mortgage

• collateralized debt obligation (CDO)

• negotiable CD

• discount bond

The growth of the subprime mortgage market led to

• increased demand for houses and helped fuel the boom in housing prices.

• a decline in the housing industry because of higher default risk.

• a decrease in home ownership as investors chose other assets over housing.

• decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages.

The global financial crisis of 2007-2009 not only led to a worldwide recession, but also a ________ in the European nations that use the euro currency.

• currency devaluation

• tax cuts

• budget surplus

• sovereign debt crisis