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

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. 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. 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. 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. 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. 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