In my opinion this whole economic problem is due to two main culprits:1. Mortgage lenders who loaned people more money then they should have
2. Institutions who loaned investment bankers more money then they should have
This whole collapse stems from the fact that lenders were willing to lend desiring home owners too much money to buy a house. So the "desiring homeowner" offered more money then they should of to buy the house of their dreams, and housing prices sored!
These individual home loans were then bundled together and sold to large investment banks as RMBS: Residential Mortgage Backed Securities. The incoming cash flow streams (and the homes) from the home owner payments (where do you think your monthly payment goes?) were used as a source of collateral for these big investment banks to borrow more money and invest it in more RMBS.
This cycle was repeated until the leverage (debt) on these RMBS pools became 30 times that of the underlying collateral (the incoming stream of cash from you monthly mortgage payment).
So the shoe dropped. People who borrowed too much for that perfect house-in-the-hills couldn't actually afford that over-stuffed mortgage (or they sorrowfully lost their job, etc.) and they stopped paying the mortgage. In the worst cases they were foreclosed upon and they lost their house. So began the home price deflation...
Then, the man with one red shoe lost his other one (the other shoe dropped!). The value of these RMBS pools declined has home values declined. Suddenly the institutions who lent money to the banks that owned these mortgages wanted their loans paid down.
Imagine here that you told your lender you wanted a loan for a Mercedes so he gave you a big fat loan. In fact, the car you bought was only a used Ford Focus. Obviously the lender gave you too much money to buy the car; he found out, now he wants you to pay down the loan! This is essentially what happened on wall street...
Everyone asked for their money back at the same time, when that happened the banks literally rank out of cash, which is why they scrambled for equity infusions, massive new loans, sales of a business unit or two, or an outright company sale.
Some succeeded, some failed. Merrill ran into the arms of Bank of America and lived (sort of) while Lehman scrambled like a lame duck quarterback and was, alas, sacked for good...
In Part 2, I'll discuss the concept of the bail out and why it matters to you!!!
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