Trying to explain the financial crisis

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Raise your hand if you don’t quite understand this whole financial crisis. It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn’t afford, and now they are falling behind on their mortgages. But the overwhelming majority of homeowners are still doing just fine. So how is it that a mess concentrated in one part of the mortgage business — subprime loans — has frozen up the credit markets, sent stock markets gyrating, caused the collapse of Bear Sterns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?

I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis. “We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist said. Robert Rubin, the former Treasury Secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,” an obscure financial contract, until they started causing big problems for Citigroup. I spent a good part of the last few days calling people on Wall Street and in the government to ask one question: “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question, “Can you try again?” I emerged from it thinking that all the uncertainty has created a panic that is partly irrational. That said, the crisis isn’t close to ending. Ben Bernanke, the Fed chairman, won’t be able to wave a magic wand and make everything better, no matter how many more times he cuts rates and cheers Wall Street. As Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.