Here’s my short theory on how this happened. Keep in mind that I am not an economist.
1). Congress has actively encouraged banks to give mortgages to the marginally qualified (and even to those not qualified based on usual credit scoring). Remember the term “Red lining”? Banks were sued for not granting loans in large enough numbers to people living in certain areas of the city.
2). Easy money by the Fed was a standard policy for way too long which encourages excesses in the markets (real estate in particular in this case). Recall the recent escalation of home values.
3). Congressional oversight of Freddie and Fanny was way too lax. F & F were generous with their campaign contributions and got a lot of slack…. too much. The WSJ and others (including McCain) were complaining about this for years. Zillions of dollars of the mortgages from #1 above were pawned off on F & F which everyone figured was safe as can be cause they are ostensibly backed by the US gov’t.
4). Following the Enron mess Congress in their enthusiasm to do something passed new accounting laws called Sarbanes-Oxley. This imposed a new rule called “mark to market” on how assets are valued.
5). The wizards on Wall Street figured out how to package the shaky mortgages into bond-like instruments that could be resold to banks and other institutions. And, like all manias everybody figured the dance would go on forever. But, the music stopped. When the bubble burst, the new mark to market rule made the mortgage assets worth essentially zero and put otherwise profitable and substantial businesses in (and this is a technical term) deep shit. Banks have strict capital ratios to maintain to be recognized as solvent in the eyes of the FDIC. Holding assets that become instantly worthless does not look good on the balance sheet.
Of course, in a big mess there is plenty of blame to go around. However, the guys who are escaping blame thus far are the guys who should get the lion’s share….. Congress. They have been essentially tossing money at this thing from the beginning (prob 700 or so billion) and now want to throw another 700 billion or more at the wall and see if that sticks. I am not at all convinced that the “bailout” is the right answer. However, in the final weeks of the election cycle it is clear that the politicians have made it their goal to use this situation as an opportunity to get elected or re-elected. And especially the Democrats who repeatedly blocked reforms of F & F and continue to encourage loans to the unqualified. Not good. Kind of like fiddling while Rome burns.
Unfortunately, I think Obama will get elected and prolong the misery. His many proposals mirror those of FDR who, if you analyze history honestly, prolonged the depression. (You can look this up). Obie thinks FDR was just great. McCain has not been swift on this crisis either.
More bailout discussion can be enjoyed (with a handful of Prozac) by reading Thomas Sowell’s article on Townhall.com. There’s also an interesting (although arguably incorrect in some aspects) article comparing the US economy to the Titanic.