One of the biggest critiques of the 2007-2008 financial crisis

Question

One of the biggest critiques of the 2007-2008 financial crisis is the concept of “too big to fail.” The "too big to fail" theory asserts that certain corporations, and particularly financial institutions, are so large and interconnected that their failure would be disastrous to the entire economic system, and therefore they must be supported by the government when they face potential failure. This is the theory Congress and the president applied when bailing out the banking system at the end of 2008 with 700 billion dollars. What the government bought was 700 billion dollars of illiquid mortgage-backed securities that the banks should not have lent to consumers in the first place, but were able to because of a lack of regulatory oversight.

These mortgage-backed securities were created from pools of loans of which the homeowners did not have the means to pay back the lender for the long-term asset. The primary reasons for homeowners’ defaulting were fixed-rate loans converted to higher adjustable interest rates, loss of employment in a recession, and underwater loans (a home purchase loan with a higher balance than the free-market value of the home). Unfortunately, while the bailout from the United States federal government may have saved the larger institutions, many of the loan borrowers found themselves defaulting on their mortgages because of unforeseen circumstances.

Since the economic crisis, the Federal Reserve and other financial overseers have made it clear that corporation size comes with costs. Now, it may no longer be in financial institutions’ interests to be “too big to fail” as they have to carry huge amounts of capital against the risk of failure, which makes enormous financial institutions cost ineffective. While massive banks have a competitive advantage in the market, the regulatory rules instituted in 2015 heavily encourage large banking institutions to break up. This is better for the borrowers, as they benefit from a competitive market and a more regulated banking industry. This being said, borrowers must stay vigilant, as big banks without enough capitalization may not completely disappear with the new regulations, and regulations can always change with new legislation.   1 
 E 
1. Which of the following is NOT brought by the author as an example of a supporter of the concept that certain corporations were “too big to fail”?

a. The corporations themselves
 b. Certain financial institutions
 c. Congress
 d. The American president
 e. Mortgage consumers
 2 
 A 
2. The author of the passage suggests which of the following as the main issue that has been resolved by the Federal Reserve and other financial overseers after the 2008 financial crisis?

a. The lack of regulatory oversight
b. The demand for mortgage-backed securities
c. Homeowners’ lack of financial means
d. The loss of employment
e. The occurrence of unforeseen circumstances
 3 
 D 
3. Which of the following, if true, would provide the most support for the author’s views on the influence of regulatory rules instituted in 2015?

a. Larger banks offer their customers lower loan rates.
b. Larger banks offer their customers higher deposit rates.
c. Regardless of their size, adjacent branches of rival banks offer identical loan rates.
d. Since the beginning of 2016, three major banks in the US have gone bankrupt.
e. Any change in the regulatory rules instituted in 2015 comes into effect only 3 years after it is made.
 4 
 D 
4. It can be inferred from the passage that which of the following will most probably happen when homeowners with underwater loans sell their houses?

a. The profit on buying and selling the houses will be less than the market average.
b. The selling prices of the houses will be less than the price they paid for the houses.
c. Their mortgages on the houses will be larger than the profit on buying and selling the houses.
d. The selling prices of the houses will be less than the cost of the mortgages.
e. The losses from buying and selling the houses will be larger than the value of their mortgages.
 5 
 E 
5. All of the following appear in the passage as government regulatory actions, EXCEPT for

a. Supporting financial institutions
b. Supervising the banking system
c. Legislating financial laws
d. Promoting market competition
e. Insuring the banking system

Source: examPAL

Nikhil · Answer

+1 kudos to all the posts containing proper explanations for all questions

srnaga · Answer

please explain question 4. option b n d are too close!

It can be inferred from the passage that which of the following will most probably happen when homeowners with underwater loans sell their houses?

a. The profit on buying and selling the houses will be less than the market average.
b. The selling prices of the houses will be less than the price they paid for the houses.
c. Their mortgages on the houses will be larger than the profit on buying and selling the houses.
d. The selling prices of the houses will be less than the cost of the mortgages.
e. The losses from buying and selling the houses will be larger than the value of their mortgages.

aragonn · Answer

Refer this part ------- a home purchase loan with a higher balance than the free-market value of the home

srnaga · Answer

Thanks i see the line.
i confused myself thinking that house is the mortgage here. Then b n d would mean the same.

arvind910619 · Answer

Hi,
Think about this problem as a total money problem.

We have to include the interest paid for the loan as well.
A is just cost price-selling price but what about the cost paid in interest.
So D includes that cost.

D is the answer.

NilsCB · Answer

Hi,

i think "The selling prices of the houses will be less than the cost of the mortgages." is not differentiating between the value of the mortgage and the costs of a mortgage. In my understanding the costs of a mortgage are interests and the repayment. So D should be clearer written, because the stated problem is, that the mortgage on a particular house is higher than the actual value of this house.

Have a nice day.

Abhishek009 · Answer

Lets try , the passage states -

The primary security here is the Home (Purchased out of Bank FInance )

Now say the market value of a House is $ 10,000 and the Balance outstanding for a particular Account be $ 12,000 (Due to charging of higher interest rates) . Now in case of a default the bank decides to Sell off the Asset/Auction the Bank will receive only say $ 10,000 (Or even Less as market conditions have worsened), this we have -

Selling Price < Outstanding Balance in Mortgage Loan Account...

Hence Answer must be (D)

manjot123 · Answer

please provide explanation to q3

faltan · Answer

5. why not E? how do we deduce A?

Abhishek009 · Answer

Insuring the Banking system has nowhere been discussed in the passage, hence options (E) is our Answer... For OPtion (A) check - This is the theory Congress and the president applied when bailing out the banking system at the end of 2008 with 700 billion dollars. , which clearly hints Governments regulator actions. Hope this helps !!

raghavrama21 · Answer

Please provide explanation to question number 3?

saurabh9gupta · Answer

For
3. Which of the following, if true, would provide the most support for the author’s views on the influence of regulatory rules instituted in 2015?

a. Larger banks offer their customers lower loan rates.
b. Larger banks offer their customers higher deposit rates.
c. Regardless of their size, adjacent branches of rival banks offer identical loan rates.
d. Since the beginning of 2016, three major banks in the US have gone bankrupt.
e. Any change in the regulatory rules instituted in 2015 comes into effect only 3 years after it is made.'

how is the answer D?

passage ref- While massive banks have a competitive advantage in the market, the regulatory rules instituted in 2015 heavily encourage large banking institutions to break up. This is better for the borrowers, as they benefit from a competitive market and a more regulated banking industry.

i still dont understand why is the answer D

LoveWildLife · Answer

Question 3...I still dont get it. Can anyone provide some explanations?

Skywalker18 · Answer

While massive banks have a competitive advantage in the market,  the regulatory rules instituted in 2015 heavily encourage large banking institutions to break up.   This is better for the borrowers, as they benefit from a competitive market and a more regulated banking industry.

3. Which of the following, if true, would provide the most support for the author’s views on the influence of regulatory rules instituted in 2015?
a. Larger banks offer their customers lower loan rates. - Incorrect - this is opposite of what the author claims- when massive banks break up, then borrowers are benefited from a competitive market
b. Larger banks offer their customers higher deposit rates. - Incorrect - same as A-
c. Regardless of their size, adjacent branches of rival banks offer identical loan rates. - Incorrect
d. Since the beginning of 2016, three major banks in the US have gone bankrupt. - Correct - Since the regulatory rules instituted in 2015 encourage large banking institutions to break up, in absence of these rules, the number of major bank bankruptcies in 2016 (following year) might have been more than three.
e. Any change in the regulatory rules instituted in 2015 comes into effect only 3 years after it is made. - Irrelevant

Answer D

yash312 · Answer

Gladiator59 
 AjiteshArun

please suggest why is option C wrong.

c. Regardless of their size, adjacent branches of rival banks offer identical loan rates.---it correctly shows a competitive market and a more regulated banking industry.

achand05 · Answer

in q5 what is wrong with C.

auradediligodo · Answer

Hi,
I don't see where the passage states that corporations themselves supported the concept of too big to fail(answer A Q1)..

auradediligodo · Answer

Hi,
I think you should refer to the last lines of the paragraph: "This being said, borrowers must stay vigilant, as big banks without enough capitalization may not completely disappear with the new regulations, and regulations can always change with new legislation."
This part of the passage warns about possible negative scenarios that the legislation won't be able to stop so the information given in answer D is an example of one of those scenarios and hence it is the right answer.
Hope that helps

globaldesi · Answer

Hi
 how can we say that 3 is also not a big number. Bankruptcy of one major bank can cause turmoil. 3 is a very big number.
C (Regardless of their size, adjacent branches of rival banks offer identical loan rates.) could have been a better solution.
Can you explain it in detail please?

One of the biggest critiques of the 2007-2008 financial crisis

Prep Toolkit

Top 5 GMAT Debrief Videos

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

My Rewards

GMAT Reading Comprehension (RC) Questions

One of the biggest critiques of the 2007-2008 financial crisis

Prep Toolkit

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

My Rewards