The question of what happened is deeper here than in any other event of our recent history. The WTC attacks by contrast are easy to understand. Even Iraq, once seeming so complex becomes almost lucid when view from the context of this event.
Perhaps more striking than the event is the Executive desire for a free hand in distributing about a trillion US dollars. This impossibility means that the measure is now struggling in a fight, a deal everyone needs but nobody wants.
The Simple History
This history is not a singular line. Rather a number of events happened between the 1980s to the present to make this possible.
1. The introduction of quant programs created massive agents of economic selection that involved running computer models. These models could be gamed by brilliant mathematics experts and other strange quants who left science and mathematics to work for these firms building bets they believed the quants would take. The quants also had another problem: a bailout function that meant as they started going down a feedback loop began.
2. Neo-liberalism grew in the 1980s with the promise after the S and L bailout that no massive end would be allowed by the government. As economic thinking and business reason extended its grip in much of the world the individuals who ran these Investment Banks became more ruthless, more powerful and richer. Corruption and happy think was well paid off. Deregulation of not only the banks, but their clients and their ownership of the media through partnerships mean the layers of oversight became thinner and thinner.
3. Monetarism, in the late 1970s Labor, Business, Government and Consumers were all united in a desire to reduce inflation. The Federal Reserve had an easy job, everyone would be happy in 2 years if they could bring down inflation, and a massive recession would do that followed by recovery. Reagan liked the idea of beating inflation before running for re-election, and the policy was followed. But the situation in the late 1990s was very different, everyone wanted easy money regardless of the long-term economic reality and the Fed gave the powers what they wanted.
4. Bush. I will go as far as to say that if Bush had never been President this would not have happened. This is because of a number of forces that drove property markets were Bush or Fed Reserve policies.
5. The fall of equity. This crisis and the Clinton years showed the critical role Federal Authority can play in deciding the winners and losers in markets. Bush and Chaney were always more interested in their contacts and IT was not pushed as it was under Clinton. IT being the major grower in the economy Microsoft, Apple, IBM, Dell, Compaq, Intel and other smaller US companies produced a new set of platforms along with Open Source to allow a new generation of technologies like Skype, YouTube, MySpace, iTunes, Facebook, Blogs, Wikipedia and other technologies that were taken up by the multitudes around the world. Despite this Republicans economic friends are less in IT than other industries, and with war and oil prices this new technology boom had less impact in attracting investment. Rather with low interest rates set in large part by the Fed the economy drove a mini boom via a radical developed in housing.
These factors all combined to provide a gaming opportunity to those MBAs and other smart operators to make easy money. Greenspan had been very proud on the markets ability to sell off its risks to others markets thus lessening the impact by spreading it. The problem with real estate is that it went the other way, risks from banks flowed in to the Wall Street and around the world.
Subprime punk loans not worth the paper they were printed on were signed at low introductory rates and then cut up and sold to the quants which had been gamed to love the things. As long as property values rose subprime was a good bet, but that's all they ever were, bets on the long term real-estate market that were loaded. They were loaded because the borrowers would later have to pay much higher interest rates. If they could the loans made money and if they could not the bank took the house and sold it at a profit. Its the same as any home loan, but this time the returns and risks were higher. Too high. They were out of line investments that for some reason that is a closely guarded secret the quants loved them, the money flowed from the Investment Banks who as the housing market was going up made money either way.
Then the housing market collapsed hard. This caused equity value of Investment Banks to go down bringing the market down further lower their asset values. Again a feedback loop developed. The banks did poorly that rattled the markets that lowered market values that lowered the bank performance.
And then I think people began to see that all of it had been a game, and trust collapsed. That is what happened radically last week, but it must have built to some extent over the past 7 months.
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