Here goes:
Fed lowers interest rates after 9/11 economic woes.
Real estate boom begins due to cheap mortgage rates.
Shady mortgage brokers are able to sell doomed subprime mortages to unqualified borrowers due to a complete lack of oversight and regulation in the industry.
Many of the shady loans have a fixed rate for 2 years that will increase after that.
Instead of holding mortgages and collecting the interest, lenders pool them together into huge financial instruments called MBSs that pay a yield like a bond or savings account based on the income of the underlying mortgages.
The fact that they are selling the mortgages off and not keeping them makes lenders care even less about the quality of the loans they write. So they write more shady loans. A LOT more.
Real estate prices go through the roof since everyone and their homeless uncle wants to and CAN buy a house now. Demand is through the roof.
The buyers of the MBSs, huge financial institutions and investment banks like AIG and Lehman ignorantly think that real estate prices can’t go down too much because after all, it’s real estate and they ain’t making more of it.
(Cue Ominous Crisis Music HERE.)
All the low 2 year fixed mortgage rates go up and homeowners can’t afford them anymore. They start to default.
The huge financial institutions, like AIG and Lehman, are holding onto MBSs to the tune of billions of dollars, thinking of it as a safe haven for their money, the way you would think of a bond.
As the mortgages increasingly default, the value of the MBSs plummet along with the net worth of the financial institutions holding them. Word gets out to consumers and some rush to withdraw their money from consumer banks causing bank collapses.
Many financial institutions, broke and scared, panic and stop lending money to each other or anyone for that matter basically freezing the flow of money through the financial system.
Without cash flowing banks can’t carry on their normal operations and smaller businesses can’t get loans for their daily operations much less to expand or grow.
The entire economy freezes, the stock market plummets with future GDP and earnings growth prospects looking terrible.
And here we are…
SOLUTION:
1. More liquidity to grease the system and get it going again.
2. A restoration of confidence in the economy.
How to do that exactly is incredibly contentious and is what everyone is fighting about now.
That’s a very concise and of course simplistic summary of the past 7 years but should be enough to help you understand and hopefully be a little pissed off because you probably had nothing to do with it but are certainly going to be effected by it…
