Chapter EMA, Problem 5MCQ

To determine

To state: The term that is not a cause of the financial crisis 2008.

Answer to Problem 5MCQ

The correct option is B i.e., a stock market crash.

Explanation of Solution

Causes of the 2008 Financial Crisis The collapse of L Brothers—a large shadow bank—set off the 2008 financial crisis, first in the country U and eventually across the globe. Although several factors led to the bank’s collapse and the subsequent worldwide economic downturn, economists have identified four major causes of the 2008 financial crisis:

1. Extreme risk-taking in an advantageous macroeconomic environment: the economic conditions in the US and other countries were encouraging. Economic growth was stable and strong, and unemployment, rates of inflation, and interest were quite low in the years previous to this one. So, this led to house prices rising powerfully. There was this expectation that the prices of the house would keep on increasing leading households, especially in the country U, to borrow recklessly for purchasing and building houses. So, banks and other lenders were eager to make gradually more big volumes of risky loans for a variety of reasons.
2. Enlarged borrowing by investors and banks: banks and other investors in the country U and abroad borrowed more amounts to enlarge their lending and purchase MBS products. Thus, borrowing money to purchase an asset expands potential profits but also expands potential losses. As a result, when the prices of houses started to fall, banks and investors suffered large losses as they had borrowed so much.
3. Policy and regulation errors: Regulations of subprime lending were too careless. In specific, there was inadequate regulation of the institutions that formed and sold the complex and misty MBS to investors. As the crisis extended, a number of central banks and governments didn’t identify the level to which bad loans had been drawn-out during the period of boom.
4. Crisis as a result of an asset bubble: An asset bubble generally arises when the asset price, such as bonds, stocks, commodities, or real estate, increases at a fast pace without underlying fundamentals, such as correspondingly fast-rising demand, to validate the price rise.

Economics Concept Introduction

Introduction:

Financial crisis: It is often regarded as a mixture of events, including considerable changes in asset prices and credit volume, severe disturbances in financial intermediation, large-scale balance sheet difficulties, especially the supply of external financing, and the requirement for large-scale government help.