Board of Governors of the Federal Reserve System

Lecture Three: The Federal Reserve's Response to the Financial Crisis

Lecture 3, Video Clip 28: Public-sector vulnerability: GSEs
Questions for Classroom Discussion:

1. Define government-sponsored enterprises (GSEs). What advantages do the GSEs offer borrowers and lenders?
2. Define securitization. Why would firms want to engage in securitization?
3. Why might securitization become a vulnerability?

Lecture 3, Video Clip 29: Bad mortgage products and practices were a key trigger
Questions for Classroom Discussion:

1. Are bad mortgage products and practices a trigger or a vulnerability? Explain why.
2. Explain why housing prices had to keep increasing in order for adjustable-rate mortgages (ARMs) to make sense for borrowers and lenders.
3. What were the roles of option ARMs, stated income loans, and no-doc loans? How were they helpful for borrowers? How did they contribute to the housing-price bubble? How did they contribute to the bursting of the bubble?

Lecture 3, Video Clip 30: Financing of exotic and subprime mortgages, inappropriate ratings
Questions for Classroom Discussion:

1. What is the role of ratings agencies in financial markets?
2. What are the incentives for rating agencies? How might those incentives contribute to the creation of a bubble?
3. What are the advantages and disadvantages of securitization of subprime mortgages for the borrowers, for the packagers of the securities, and for the buyers of the securities?
4. What was the role of insurance of those securities; that is, what was the role of credit default swaps?

Lecture 3, Video Clip 31: The crisis: Narrative of a classic financial panic
Questions for Classroom Discussion:

1. Define a classic financial panic.
2. What happens in the short run? In the long run?
3. What is the difference between a solvency crisis and a liquidity crisis?
4. How can the entire system be endangered if just a few banks or financial institutions have solvency or liquidity problems?

Lecture 3, Video Clip 32: Overview of the policy response to the financial crisis
Questions for Classroom Discussion:

1. Describe the various elements of the policy response to the financial crisis.

Lecture 3, Video Clip 33: Did the policy response work?
Questions for Classroom Discussion:

1. What evidence is relevant to determining the success or failure of the policy response?
2. Can you summarize the evidence?

Lecture 3, Video Clip 34: Federal Reserve actions: The discount window and liquidity and credit facilities
Questions for Classroom Discussion:

1. Describe the role of the traditional tool of the discount window in halting bank runs. Why was additional action needed?
2. What are the alternative tools? How were they intended to prevent potential bank runs?

Lecture 3, Video Clip 35: Case study of money market funds and the commercial paper market
Questions for Classroom Discussion:

1. What are money market funds and the commercial paper market? What is the relationship between the two? Why are they important in this context?
2. What roles did they play in the financial crisis?
3. What is the importance of the federal guarantee of money market mutual funds? How is the money market connected to corporate costs of borrowing?
4. Why might there be a panic if depositors and lenders believe that there will be some small amount of trouble? Why would a customer want to be the first to withdraw funds? What are the consequences for the system?

Lecture 3, Video Clip 36: Support of critical institutions
Questions for Classroom Discussion:

1. What is a "too-big-to-fail" financial institution?
2. Would it be better to let those institutions fail, so as to discourage future risky actions? Why or why not?

Lecture 3, Video Clip 37: Consequences of the crisis and comparison of the crisis to the effects of the Great Depression
Questions for Classroom Discussion:

1. Summarize the effects of the financial crisis on the real economy. Compare and contrast those effects with the effects of financial crises during the Great Depression.
2. Summarize the effects on the stock market. Why is that relevant for the average U.S. worker who might not directly or even indirectly own shares of stock?