Wednesday, October 15, 2008

Financial Crisis: The Who, What, When, Where and Why

As of this writing, the Dow Jones is down 306 points, just two days after European governments super-charged the world's markets by laying out aggressive programs to deal with the frozen credit markets. The United States also announced a program to deal with the crisis, but markets have been weak-to-faltering even as the newspaper headlines start to sound optimistic for the first time in weeks.

What is happening? What will happen next?

Much of the problem stems from the easy credit and large amounts of money lenders were pushing into the housing market for many years. And though some critics have put blame on the people who bought subprime loans and other insufficiently securitized financing, "the people who should have know what they were doing was people who had experience lending money," said former Secretary of Labor Robert Reich in a Commonwealth Club speech October 1, 2008 (see the embedded video above for his complete speech). "I think they did know what they were doing."

Perhaps they didn't. In the same speech, Reich said that he spoke with Wall Street financiers about the various financial instruments they were using to repackage bulk loans and sell them to investors. "Two years ago I asked a hedge fund manager, 'Please explain to me what's in your hedge fund,'" said Reich. He said the fund manager laughed and replied, "I have no idea."

"Thanks to high technology, you could slice and dice these [financial] packages into your appetite of risks," Steve Forbes told The Commonwealth Club on August 7, 2008. "You could have packages of sub-prime mortgages; you could own a piece of it that may be worth today 80, 90 cents on the dollar. you could own another piece that is zero cents on the dollar. Lots of institutions didn't even really realize how much of this junk they had until the crisis hit."

That, say experts, has led to the frozen credit markets, where banks are unwilling to lend to other banks because they literally don't know if the other bank's liabilities in bad loans are frighteningly awful or just frightening. Therefore, we've seen governments stepping in to provide liquidity for banks and trying to provide the confidence banks need to make the loans.

Where this will all lead is not clear, though even the optimistic predictions of many economists is that the United States is in for a serious recession lasting one or two years. That has people and businesses battening down the hatches and preparing for a tough time.

"The consensus among mainstream economists is if – if – we can avoid a meltdown, this is likely to be an extended but comparatively shallow recession," said Peter Gosselin, a financial journalist who spoke on a Commonwealth Club Inforum panel on "Surviving the Great Recession." He added that even a "shallow" recession can be very serious. That panel discussion was in July, but even then Gosselin said the country was likely to hit a crisis soon. Events would soon prove him correct.

ADDENDUM: The Dow Jones closed down about 733 points.


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