This is the best explaination of the crisis that Ii have seen, from a SF writer:

http://www.chaosmanorreviews.com/oa/...080923_col.php

Computing At Chaos Manor:
September 23, 2008
The User's Column, September, 2008
Column 338, Part 2
Jerry Pournelle jerryp@jerrypournelle.com
www.jerrypournelle.com
Copyright 2008 Jerry E. Pournelle, Ph.D.



In the June issue of the column I recommended The Black Swan to anyone interested in statistics and financial security. I've mentioned the book and the concept many times over the years, latest at this link. If you haven't paid attention, you may want to do so now. The financial crisis isn't over.

In the past month, investment banks managed to lose more money than all the banks in history cumulatively have made as profit on risky investments. Lehman Brothers, which survived the Civil War, the turbulence of the late 19th Century, World War I, the Crash of '29 and the Great Depression, has vanished. Major stockbroker houses, which used to know that the first rule was never to gamble with house money, collapsed. Note that the crisis was easily predicted by anyone except the smartest guys in the room who controlled America's financial centers. They, apparently, couldn't see it coming.

It is time to lay out, in very plain language, precisely what happened; and while I do not usually make this kind of comment here (as opposed to my comments in The View From Chaos Manor), this crisis greatly shrinks our pool of investment capital and thus affects all our high tech industries; and the smartest people in the room ó and this is common to the leaders of both major political parties ó either do not understand that what happened was predictable, or pretend not to.

As often (but not always) happens when government interferes with economics, the origin of the collapse was due to good intentions. Aristotle tells us that democracy is rule by the middle class, and the middle class are those who possess the goods of fortune in moderation. Most political scientists, economists, and intellectuals in general are agreed that ownership of one's home is a key element in defining the middle class in America. It's neither necessary nor sufficient, but it's still important, and the more people who own homes, the more people with a stake in America and the existing social order. People who own houses work hard to keep them. Home ownership is good for the owners, and it's good for America.

It was decided that the usual market forces weren't sufficient to spread the joys and benefits of home ownership, and government help would be needed. There are several ways that might be done including taxing the rich, buying houses, and giving them to those who couldn't afford them, and that was actually proposed at one time; but sanity prevailed. After all, if you could get a free house by being poor, why work hard to save a down payment and take out a mortgage? Better to spend yourself poor...

Eventually a solution was found. Private corporations called Fannie Mae and Freddie Mac were established with government backing, and by implication, government guarantees. These firms, managed by executives paid on the modern scale (millions to hundreds of millions in 'incentives' and bonuses), were sent forth to make it easier to own a house by making it easier to get a mortgage loan on that house.

This meant that people who couldn't convince bank loan officers that loaning them money would be profitable were able to borrow money because the government guaranteed the repayment. Fannie Mae and Freddie Mac could obtain money at low interest from the Federal Reserve System. Of course the Feds don't have any money ó the budget runs a deficit ó but it's easy to print some and borrow more by selling Treasury bonds, so Fannie Mae and Freddie Mac were well financed at low interest. Given those loan guarantees to lenders, people who otherwise would not be able to buy a house were enabled to do so. And of course as more people were able to enter the housing market, more bids were made on houses, and housing prices rose. As prices rose, the construction industry was stimulated to build more houses. Employment went up. For a while everything worked about as hoped.

More at link......