Journalists aren't describing what's happening to the economy; so I guess I have to.

Bush said he isn't going to allow wasteful spending and tax increases by the democrats. The democrats said he is the one who turned a balanced budget into an economic disaster. Bush has been claiming that he created a thriving economy by giving a couple trillion dollars in tax breaks to Wall Street investors. Investors are supposedly the ones who know what to do with their money, unlike the welfare queens who squander it at Wal-Mart. A few years ago, Greenspan told investors that their heavy investment in stocks is "irrational exuberance;" so they decided to invest Bush's tax gift in real estate.

Real estate created a different kind of economic bubble. For every real dollar invested, huge amounts of borrowed money followed, since real estate provides the collateral which lenders feel secure with. Added to this effect was another trend which expanded the size of the bubble again. The debt was packaged and bought and sold ad infinitum by hedge funds.

If it were nothing but a real estate problem, or even an economic down-turn, Wall Street would have yawned. But yawning isn't what they were doing yesterday. They were saying: "No one should panic." "Don't do anything irrational." "Just wait and see what happens." They seemed to think people were just going to go back to work after the stock market dropped 2%. Do people jump off of buildings when Wall Street loses money? Wall Street was scared.

For the past several weeks, economists were saying banks did not appear to be affected by real estate losses. Now they are saying a problem developed, because banks cannot borrow the money they need to operate by. Lenders are afraid they won't get paid back. This logic does not have a literal interpretation. Banks do the lending; they don't need to do the borrowing beyond an automatic source from the FED which was never in question.

Behind the veil, the hope was that the buying and selling of bad mortgage debt by hedge funds would only affect hedge funds and not the banks. The money industry thought they had a mad lion in a cage where it was safe. Yesterday, they saw the beast escape from the cage.

Over the past few decades, someone made $485 trillion on derivatives. Or did they lose $485 trillion on derivatives? No one knows. How do you define the difference? Since the debt can't be paid, it can't be collected. It just sits frozen in space. Economists told themselves that it's no problem, because "banks have no exposure to it." Banks thought they had it walled off from the rest of their operations. Yesterday, they found out otherwise. It's like thinking there was a cage around a mad lion and finding that there isn't.

The bad mortgage debt bought by hedge funds was another variation of derivatives. As such, it should have disappeared into nowhere along with the rest of the derivatives. But some bankruptcies were involved. This means lawyers go out and collect all related assets. Lawyers don't see a la la land where you stash debt in an unaccountable way. This started a process of debt collection. Bankers weren't playing by those rules. If one person collects, they all have to collect. This process of collecting on debts created a rope which runs back to all $485 trillion tied up in derivatives. Wall street saw that rope being pulled, and it scared them.

Update: December 5, 2007

Here's a New York Times article which clearly describes one element of the problem—the breakdown of the lending process by banks. What it says is that banks can no longer borrow the money they need, because lenders don't trust their asset base which is needed to back up the loans. The reason why the asset base is not reliable is because it consists of nothing but derivatives in endless forms.

technical details - by Tarpley
the bailout - by Allan Sloan
Derivatives Expert (Das) Explains
Recent criticism, April 11, 2008