Sunday, October 05, 2008

Blame Washington Not Wall Street for the Sub-Prime Crisis

The collapse of many financial institutions and the implications of this for the economy is the major economic concern in the United States and around the world as we head into the last quarter of 2008. The immediate cause of the crisis is the drastic reductions in the value of the assets of financial companies due to the large number of sub-prime (low credit quality) mortgages in their portfolios. However, the sub-prime mortgage problem is a sub-set of the collapsing of the housing market bubble. Basically, rising demand for housing and the profits to be made in meeting this demand led to increasing numbers of people moving into the housing market and seeing it as a means of getting rich. As prices continued to rise and thousands of people became wealthy as a result, more and more people jumped into the market. In times of frenzied activity in the market for a particular good, housing in this case, the mania takes on a life of its own as increasing numbers of people rush into the market hoping to get rich while knowing nothing about the mechanics of investing. At some point prices peak and those who entered last panic when they suddenly realize that rather than making large amounts of money they are about to lose everything. Their reaction is to cut their losses and sell, an act that begins to drive prices down causing others to begin frantically selling in their haste to exit.

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Blame Washington - Not Wall Street for the Current Financial Crisis