I was reviewing the current economic situation with some people at work the other day and it was evident that two things were pretty clear to them: one is that we are in a big mess and two is that most people do not understand how we got into this mess.
Vanity Fair has a really good piece on the cause of the economic turmoil which you can read at length here.
My read of the major causes of the economic chaos from their article:
- Real Estate: flawed U.S. government policy, or social engineering dogma, that every citizen should own a house
- Securitized Debt: converting debt like mortgages, car loans and derivatives into securities which made it difficult, if not impossible, to assess the value of the loans
- Subprime Mortgages: the securitization of mortgages made it possible to take on riskier loans such as subprime mortgages, as long as they were bundled with better risk loans. This strategy worked for as long as real estate prices kept rising and interest rates remained low.
- Quantitative Analysis and Options: securitized debt was insured by swap options based on the irrational belief that everyone in the market would behave rationally
- Cheap Money: China had high savings rates and that money was loaned to the U.S. where the money was then used to make bad loans