Financial Fragility and the Lender of Last Resort

1. Describe the traditional and modern theories of financial crises and their economic effects.

2. How are adverse selection and moral hazard problems worsened during a financial crisis? What signals that these problems are worsening can policymakers look for?

3. Why did the Fed intervene in the financial system following the 1970 Penn Central default and the 1987 stock market crash? Is there a drawback to such intervention? Explain.

Source: "Financial Fragility and the Lender of Last Resort." Desiree Schaan and Timothy Cogley, Federal Reserve Bank of San Francisco Weekly Letter, No. 95-21, May 26, 1995.