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

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One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 10:04
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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


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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 18:48

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


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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 19:32
workout wrote:

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


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.
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 19:34
Refer this part ------- a home purchase loan with a higher balance than the free-market value of the home
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 20:19
aragonn wrote:
Refer this part ------- a home purchase loan with a higher balance than the free-market value of the home

Thanks i see the line.
i confused myself thinking that house is the mortgage here. Then b n d would mean the same.
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 01 Dec 2018, 22:02
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srnaga wrote:
aragonn wrote:
Refer this part ------- a home purchase loan with a higher balance than the free-market value of the home

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


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.
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 02 Dec 2018, 00:20
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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.

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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 02 Dec 2018, 10:53
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srnaga wrote:
workout wrote:

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


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.


Lets try , the passage states -

Quote:
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).


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)
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 02 Dec 2018, 23:14
please provide explanation to q3
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 03 Dec 2018, 05:38
5. why not E? how do we deduce A?
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 03 Dec 2018, 05:54
faltan wrote:
5. why not E? how do we deduce A?

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 !! :blushing
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 05 Dec 2018, 22:33
Please provide explanation to question number 3?
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Re: One of the biggest critiques of the 2007-2008 financial crisis  [#permalink]

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New post 10 Dec 2018, 20:30
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
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Re: One of the biggest critiques of the 2007-2008 financial crisis &nbs [#permalink] 10 Dec 2018, 20:30
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