I’ve seen plenty of questions floating around on Yahoo! Answers and elsewhere from average investors or other individuals asking for clarification of why the recent meltdown is occurring. Questions range from: “Why are the world markets going down?” to “Why is this happening?” I’ll do my best to provide a relatively non-technical/financial explanation of what’s going on, both domestically in the US and abroad to bring individuals up to speed.

Basically, banks became greedy a few years ago and started selling blocks of mortgages together as assets which others could invest in. (So if you owned a mortgage, it might be sold as an investment to a number of different people/institutions). The problem was twofold in this regard. First, these packages that were being sold were extremely complex so most people buying them couldn’t see what they actually were. A single mortgage could be sliced into many different portions, repackaged, and then have that package sold again and repackaged, etc. The common analogy is that the “bad debt” was like rotten meat thrown into a grinder, so that the banks only knew if they had it after they were already sick.

Secondly, the banks were greedy in that they were giving out mortgages to people who shouldn’t have normally been able to afford them. So, the “sub-prime” was basically giving away teaser rates to individuals who wouldn’t be able to afford the “normal” mortgage payments. For instance, if an individual had $2,000 they could allocate to their mortgage, a bank would issue a mortgage to them at a teaser $1,800 payment, knowing that the real payment would be around $2,500 after a few months. So in essence, the banks knew that the individual would not be able to afford it, but they would get a few months worth of payments, then reposes the house, and sell it again to make a profit. That practice was supported because all the housing prices were so high (so the banks never really lost money).

However, when the housing prices fell, all of a sudden the banks couldn’t resell the houses for what they paid for. There was literally trillions of dollars of “bad debt” in these packages - holdings which were worth nothing that the banks had to write off. Because the packages were so complex though, it was hard to tell which banks were holding which bad assets (think of a horrific game of bank Russian roulette – no pun intended with the status of the Russian markets). So, as they discover them, and have to write off hundreds of millions (or billions) at a time, the banks are being forced to go out of business – hence all the collapses recently. This creates an environment where no one trusts each other.