Explain the current economic crisis in layman's terms?

Because I read bits and bobs here and there, and for the most part I really don’t understand what they’re talking about, specifically, beyond OMG! It Is Bad™!

Keep in mind I’m not a math-head and my understanding of money is more concrete than abstract: I give her goods or services, she gives me money; I give him money, he gives me goods or services. Stuff like “short selling” defies logic to me (“here, let me sell you stuff I don’t actually own” – who would be dumb enough to buy something that doesn’t exist?) so you’re going to have to work harder on those types of things. :stuck_out_tongue:

I understand that Something Bad happened with a ton of mortgages, and it’s bad, in part, because of the sheer numbers of mortgages that went bad. I understand that the net result is that a lot of people either default and get foreclosed upon, or they attempt to sell and the house sits on the market forever, so home values drop just because so many people give up and sell at a lower price than they wanted just to get rid of the albatross. This apparently is doing Something Bad to Wall Street, but I don’t know what or why. I know it’s affecting unemployment, but I’m vague as to how beyond the general “the economy sucks so no one has money to spend” kind of thing. I know the government is planning some record-setting bail-out, but I don’t know what or how exactly it’s supposed to work.

I don’t really “get it” beyond its immediate effect on me – i.e. lay-offs, as I’ve never had enough disposable income to invest in either the stock market or real estate… and then again, I lose my job every couple of years because of some downturn in the economy, so what’s so special about this one? There’s either some fantastic scare-mongering going on, or this economic crisis is worse than the last one by a few orders of magnitude.


Here’s the short version: a lot of banks have much more liability than they thought, and nobody knows exactly how much they or anyone else have. So banks are refusing to lend to each other because they’re worried that the banks they lend to won’t be around to repay their loans. Credit is the lifeblood of the global economy, and if it’s cut off at the source, the whole thing dries up.

That’s very simplified, probably to the point where I should be accused of making it too simple. But in a (small) nutshell, that’s what’s going on these days.

Think of short selling as borrowing something and selling it for money, then buying it back (when it’s hopefully cheaper) and returning it. You’re not selling something that doesn’t exist – you’re selling something that doesn’t belong to you, on the condition that you will return it (or specifically, something equivalent to it) by a certain date/time.

You can think of an analogy like this: Your friend has a storage shed full of bottled water for the future. Say you decide that water is going to get a lot cheaper tomorrow, so you make a deal with him where you pay him a small fee (or interest or whatever), and he will let you borrow a few hundred bottles of water until next week as long as you replace them with equivalent bottles by that time. You take the water, sell it, wait for it to get cheaper tomorrow, buy back the number of bottles you owe your friend, and pocket the difference. If water doesn’t get cheaper you don’t make any money. If water gets more expensive, you have to use money out of your own pocket to cover the difference to replace the bottles you owe your friend, so you lose money.

So why aren’t new banks starting up that don’t have these dodgy loans?

This was most informative for me and it has stickmen :slight_smile:

You (or someone) is going to need to expand on that quite a bit for me. For starters, it makes me wonder why the bigwigs in a money-handling industry didn’t think to hire an accountant to keep track of how much money they owe? I assume they’re not that stupid. I hope they’re not that stupid.

Who’s going to loan them the startup capital?

It’s not, I don’t think, that they don’t know what they owe. It would be more accurate to say that they don’t know what amount of the money they are owed they will be able to collect.

As I understand it, they don’t know how much they owe because they bought bundles of mortgages. The bad mortgages (made to people who for various reasons are less likely to pay off said mortgages) were bundled in with the good mortgages and sold as a package of good mortgages. This was fine until people started failing to pay on their mortgages and banks realized how much they overpaid for the bundles.
In this case, you could assign blame to the people that deceptively bundled the mortgages, or to the people who bought the bundles for not looking more closely at them, or the people who sold the mortgages to those who likely couldn’t pay them, or the people who signed up for the mortgage that was financially unrealistic for their given situation.

I achieved this limited layperson’s understanding by listening to "The Giant Pool of Money" episode of This American Life.

Okay, so why lend money to people whom you could be reasonably sure wouldn’t be able to pay you back? The odds of making money off of that are ridiculously low. I don’t see what the benefit was to the lender (nevermind the borrower). Were they basically counting on being able to lie to someone else to get them to buy crap? And isn’t that fraud?

How does this relate to Wall Street? How are mortgages connected to stocks? I keep hearing a lot of seemingly alarmist/hysterical stuff – “Great Depression” keeps getting bandied about – is it actually possible for this to be a long-term thing? If I could buy a condo now, would I be screwing myself by ultimately paying way more than it’s worth? If I start buying all the cheapo mutual funds with “buy low, sell high” in mind, am I basically throwing the money away as the market continues to tank over the long haul?

(FWIW, retirement, if it’s even possible for me, is at least 30 years away.)

Missed the edit window:

Actually, if someone could write a few-paragraph summary, that might be a better jumping off point than my just throwing out a ton of random questions.

PaulParkhead has the basics of it, although the mess of derivatives makes it a lot more complicated. I’ll try for a brief summary in a bit.

I can’t concisely answer your second question, but I can answer the above. Mortgage brokers knew that they could pass on the bad mortgages bundled with the good ones. They weren’t the ones who were going to be on the hook with the debt. Those selling the mortgages were getting huge bonuses and profits from signing people up for mortgages. As long as willing investors were snapping up the bundles no questions asked, they could continue passing on the debt for a profit.
They packaged the crap loans along with good ones to spread out the risk, plus the inflated housing values made the loans look like there was more value behind them. This made the mortgages look like a better deal than they really were.

Private and corporate investors and depositors. Same as normal banks.

I’m going to cheat a bit and cite post #2 in this thread as a good overview of what’s been going on.