Here is what happened. In 1999, Separation of commercial and investment banking was re-appealed (Glass Steagall 1933) The tech bubble burst. Allan Greenspan (Fed chairman) panicked and dropped the Fed fund rate to around 1%. Everyone jumped into housing (since house prices only go up). Banked issued mortgages, then rolled them up to create Mortgage Backed Securities (MSB) bonds. Theses bonds were sold to "investors". Tranches were created within the MBSes (more risk == higher yield). The rating agencies rated MBS as AAA. Housing was always going up, so if someone defaulted the bank repossessed an appreciated asset. Therefore, no risk. Banks sold MBS so they no longer carried the mortgages on thier books. There was no reason to be conservative with issuing mortgages. Enter sub-prime. Pension funds, institutional investors etc bought MBSes. To hedge their bets (protect from default) their bought MSB default insurance -> Credit Default Swaps. Everyone was making so much money trading MBSes and CDSes that no one asked what the heck was inside the actual "investment". Banks started drinking their own kool-aid (buying MBSes & CDSes). Then people stated defaulting on their mortgages. Housing stopped going up. Banks and "investors" started asking questions about the content of their "investments". and NOBODY new what they had. LIBOR (the overnight intrabank lending rate skyrocketed. Investments were carried on the books as mark-to-market. The market froze. So banks had to write down the value of their investments. The people holding the swaps were asked to pay up. Freddie, Fran, AIG, Bear & Lehman collapsed under the pressure ($135 trillion derivatives market). The Eurobanks bought heaps of swaps. The US Gov't came in a with a bailout (some money went to EuroBanks), and the Fed dropped rates to zero (some Fed loads went to EuroBanks). And most importantly the Gov't appealed the mark-to-market rule. Banks could now value the MBSes & CDSes at whatever they thought was reasonable -> mark-to-model. Voila, recovery! "Profits" are created from the improved "value" of the mark-to-model. Last month the CDS mark was $288 trillion. EuroBanks have learned their lesson. They bought swaps against their Greek, Port & Spanish debt. The US banks didn't learn their lesson, as they hold the other end of the swaps. When, NOT IF, but WHEN the Eurozone collapses it'll take the world economy with it. So in effect the people to blame are Greenspan, the rating agencies and congress for re-appealing Glass Steagall. Oh ya, congress also allowed Fran, Freddie and the big 5 investment banks to leverage their capital 30:1 (3.33% loss wipes them out). In summary, housing will not recover therefore the global marketplace cannot recover. The past 10 years of world growth was fueled by excessive and increasing leverage/credit. Today people are de-leveraging. This is a very tough investment environment. ~:-(
