SavingFreakonomics — Financial Crisis and the Markets

This took a good bit more time to write than I first expected, but I finally have it under control.   In Clear English Please we looked at the history of this debacle.  Now we will look at how it has trickled into the market. 

So Fannie and Freddie not only had these toxic loans sittin on the books but they decided to share with everyone else.  As part of their business plan Frannie and Freddie bundle loans into an investment called a mortgage backed security (MBS).  As the loans are paid off the security gains money.  These securities can be bought and sold just like stocks on the stock market (although this is done in the securities exchange).  So investment banks like Bear Stearnes and Lehman Bros. invested in these MBS.  Once again things went well until the prices of home started to fall and people started walking away from their mortgages. 

At this point the value of the MBS fell dramatically and the companies that invested in them began losing their shirts.  This is why so many banks are being bought up by other banks right now.  You see the fundamentals of these banks are strong, but they have some investments that are so bad their stock is plunging.  When the stock of a company that has a good business structure plunges they become a buyout target.  That is why Wachovia is being fought over by Wells Fargo and Citi.  

So now you have stocks of big banks losing value and thus the overall market falls.  So people who invest in mutual funds that are based off of the market as a whole also see their investments go down.  This is  how you saw 700 points in one day.  

Overall this is probably not going to end in Armageddon. The biggest thing is to let the markets adjust and everything will settle out.  Of course our government isn't going to just let it happen so we will have to see what their plans do to either worsen or prolong the current situation.