When you model an economy on Vegas principles, you’re bound to lose.  That is precisely what we have done.  Americans gambled by borrowing and living beyond our means, and our banking systems gambled that we would somehow miraculously find a way to pay it all back.  Well, we didn’t find a way, and so here we are- scalding in the lava of a financial meltdown.   Furthermore, if history is any indicator of what to expect, this situation will potentially worsen before it gets better.  To minimize the damage and rebuild what we have lost, we must gain a unilateral understanding of how we got into this mess.  First and foremost, we need to accept some responsibility, and recognize that we all played an important part in this crisis.   In 2007, the debt to income ratio for Americans was 130%.  This means that we were spending all the income we generated, and then some.  In plain terms, we spent nearly a trillion dollars more than we earned.  Because of the housing boom and liquid credit markets that existed since the late nineties, we assumed challenging mortgages, purchased investment and vacation homes, demanded high-energy vehicles, and maxed out our credit cards- assuming the boom would continue and we would meet all our financial obligations.  Who did we turn to in order to finance all this?  That’s right- American banks.   Would you lend money to someone whose debt to income ratio was 130%?  Well, our lending institutions in this country did exactly that.  Banks made what are called subprime loans.  Subprime loans are issued to people whose credit is substandard.  These types of loans carry high interest rates and thus are profitable, but they also carry high default rates, and thus are considered risky.  Banks leveraged this risk by securitizing mortgage payments and credit portfolios and selling them to investors; turning an enormous profit in the meantime.  The most important of these are known as Mortgage-Backed Securities (MBS), and they are an integral part of the global marketplace.   Risk often means great rewards to investors; the riskier the investment, the higher the return.  American investors purchased the MBS, betting that more borrowers would pay than would default, and that the housing boom would continue.  However, as we all know, the housing boom did not continue.   Eventually, homeowners began to default on their loans.  The predatory lending practices that were widespread during the housing boom were starting to have an effect as teaser rates and other favorable terms expired, and homeowners found their interest and payment sometimes doubling or more.   Investors began to flee mortgage-backed securities too late, while banks simultaneously either failed altogether, or greatly tightened lending requirements.  In fact, the tightening of credit not only applied to mortgages and credit cards, but banks also stopped lending to each other.  This resulted in the credit “freeze”.  The credit freeze has made it nearly impossible for most companies and businesses to perform or procure work; resulting in layoffs, closings, sell-offs, and one of the highest unemployment rates in American history.   As homeowners defaulted on their loans and abandoned their properties, this coupled with the great surplus of homes built during the preceding few years served to drive the price of existing homes downward dramatically.  For many, homes were devalued to the point that they were worth less than the mortgage itself.   Thousands of people lost more than just money- they lost their life-savings and their livelihoods.  The personal wealth of Americans in general plummeted.   It certainly didn’t help that, during all of this, we also experienced an oil crisis.  Because of this, we are paying more for literally everything; from daily commuting expenses to groceries.  For the first time, Americans as a whole have begun to feel the strain of an economy gone astray.   We can see now where we have gone wrong: we as individuals gambled our personal wealth and spent beyond our means.  Our banking institutions gambled by looking the other way and ignoring pertinent information while making us loans that they should not have made.  Investors gambled that just the right amount of people would pay, and that just the right amount would default.  We all gambled that the housing boom would continue, and we all bet that our prized American lifestyle could not be interfered with.  But this is one bet that we lost- so far to the depressing tune of $700,000,000,000.   The question now is: “What are we going to do about it?”  Well, some tottering steps have been taken.  Six months ago Americans received an economic stimulus package.  Recently, our government rescued several organizations, and assumed a great deal of unhealthy mortgages.  Last week, we passed the “bailout” legislation.  But what more is the financial sector doing to solve these problems, and what will all this mean as we move toward 2009?  Bookmark this blog for clear, accurate answers!     –