How'd We Get Here?

These are tumultuous times we live in. Banks are failing on what seems like an everyday basis. The stock markets are on an insane roller coaster - free falling one day and rebounding (somewhat) the next. Monday (9/29) saw the largest single-day point drop in history: 777 points lost on the Dow. Why? Because the House of Representatives failed to pass the economic bailout plan. But the most terrifying part of Monday's historic drop?: An estimated $1.2 trillion was lost in the equity markets yesterday.

$1.2 TRILLION.

It kinda makes that $700 billion requested by Bush and the Treasury seem not as scary eh?

Thankfully the market rebounded today, recovering 485 of those lost 777 points. So what's going to happen now? Congress is working on getting another economic bailout plan passed. The public is so far unaware of the details of the plan. It's likely that something will pass - our economy will be in dire straits if nothing is passed.

But how did we get here? How did our great nation, proud and wealthy, find itself sinking deeper and deeper into a financial depression? How did it come to needing $700 billion in taxpayer dollars as our only hope in warding off further economic disaster? Some of my faithful readers (as few of you as there are!) have asked me to put in simple terms the reasons for this fiasco. I'm no economist, and have only a loose grasp on the details, but I'll do the best I can.

During the past 7-8 years, our nation has been booming with growth. Stock markets were steadily climbing, the housing market was thriving and average Americans were enjoying more and more of the good life.

Credit was easy to come by. I was only 18 when I started receiving countless "pre-approved" credit cards offers in the mail. I'd get 5-10 a week.

With a growing housing market and easy mortgage loans to come by, people found out they could purchase their dream home at an amazing interest rate. Then they figured in a couple of years, they could refinance their mortgage at a lower rate and their house would have increased in value - thus gaining precious equity. [Equity is essentially the amount of money you have paid back towards the original loan for your home.]

Yet there was a catch. Banks and lending agencies were granting loans to people who probably would not normally qualify for such a high amount. Literally, a person making a $40,000/year salary could qualify for a loan to purchase a $500,000 house - assuming he or she shopped around. Remember those Countrywide commercials on TV?

The loans that these people were qualifying for were also tricky loans. They were option ARM loans (ARM meaning adjustable rate mortgage - the interest rate can change) (option, meaning the person taking out the loan could opt to pay only a portion of their monthly payment and have the remainder tacked on to their principle). Next came the downturn of the housing market when growth began to slow and homes weren't being appraised as highly.

This meant that after a year, or 18 months, when the adjustable rate of the home owner's mortgage went up, Mr. 40k/year couldn't afford to make the higher payments. So what happened? John Doe would opt to pay only a portion of his monthly payment, and add the rest to his total amount owed. What ended up happening is the amount owed for the house started to rise, and eventually overtook the amount the house was worth.

At this point, people started giving up. They stopped making their monthly payments, and some simply walked away from their houses. As this started happening more and more, the banks and other lending institutions started feeling the pinch. They had loaned out money, and now were not getting their return. More and more homeowners found they couldn't afford their homes and more and more lenders were forced to foreclose on the houses.

With a backlog of houses that were sitting empty due to foreclosure or abandonment, banks and lending institutions began writing off the losses on their financial statements. It started relatively small, but eventually institutions were writing off billions of dollars in losses. This scared investors (rightfully so) and they began withdrawing their investments in companies like AIG, Bear Stearns, Lehman Brothers etc.

Investors weren't the only ones taking their money of the these companies. Banking customers who kept their deposits with banks like Washington Mutual started emptying their accounts too.

Sometimes in a matter of a few hours, the share price of some of these companies fell to just pennies. Investors, individual and institutional alike, lost billions and billions of dollars.

And that is essentially where we are today. That's the short and not very detailed account of why our government is asking for $700 billion and why things are so scary on the stock market right now.

Yet out of the ashes of this financial catastrophe will arise a few stronger companies whose prospects and fundamentals are solid. It's these companies that will allow investors a chance to secure their future financial freedom. That's why I'm looking anxiously at the market right now, licking my chops. There are some amazing companies whose share price is depressed right now due to this crisis. But it will pass, and the share price will rise. Perhaps it's time for you to get in on some great companies!