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Bob and Sue, a young married couple had always dreamed of owning a home, but with no down payment and limited income it seemed out of reach, until they were offered a low-interest loan to purchase the perfect house. Sure, there was an accelerated balloon payment in about three years, but Bob’s income would increase by then and, worst case scenario, they would sell the house for more than the purchase price and pay off the loan. Unfortunately that’s not what happened. Housing prices declined, the payment went up, and Bob, a building contractor, lost his job. Today, Bob and Sue are losing their home at the end of the month. They fell victim to one of the biggest financial meltdowns in US history.

This scenario isn’t too far away from the truth. Just recently millions of people lost their jobs, houses, and their hope. But just what happened to the U.S. economy in 2007 – present?  The answer is that the United States banking system in plain and simple words became insolvent.  Bad loans offered during times of prosperity were sold off to domestic and foreign investors and became worthless bonds. This was the catalyst for the insurance companies, like AIG to exhaust their resources trying to cover these bad deals. This led to the downward spiral that is today’s crash.

The question many people wanted answered was how did this happen and what are we going to do about it?  Not a simple answer, but here are a few explanations for what caused this crash and possible solutions.

Easy credit, plentiful jobs resulting in plenty of money, combined with mortgage backed-securities enabled people, investors and institutions to over invest in the U.S. housing market. This combined with peoples’ expectation that home prices would continue to rise, led to huge defaults on sub-prime loans (where the borrower has a greater risk of defaulting and therefore pays a higher interest rate) and ARM’s (adjustable rate mortgages where payments can balloon beyond one’s means to pay).

Predatory lending and deregulation were additional contributors to the economic meltdown as well.  Consumers were lured by low initial interest rates which were unsafe and unsound and which would later convert to a higher amount.  Also regulation did not keep pace with new financial innovations. In fact, laws were passed but not enforced or the laws passed were weak and unnecessary, allowing self-regulation to take its place.  This was a recipe for disaster.

One last cause worth taking a look at is the idea that Capitalism itself is to blame.  It has been suggested that a surplus of money, which could not be placed in productive capital investment, was instead diverted to financial markets. This combined with deregulation and human greed was the real cause of the financial meltdown.

The impact of this collapse is that credit markets crashed, and corporations couldn’t get loans to fund operations.  Consumer credit lines were slashed or became non-existent.  Spending slowed to the point where businesses were forced to close and unemployment soared.

So what was done to counter this collapse? The immediate response to this was the controversial 700 billion dollar bailout of financial and business institutions.  This was then followed up by a 1 trillion dollar stimulus package to offset the decrease in private sector demand.

Long-term goals will involve more in depth and forceful regulation, and possibly even a governmental watchdog agency to keep laws enforced, to ensure that human greed doesn’t get the foothold it had during and before this crisis.

But no matter how popular or unpopular the U.S. government’s liquidity injection into the credit market is, it probably staved off a global financial collapse.  CSUS retired Economics Professor Albert Lee called it “a necessary evil.”  The purchases of troubled financial entities and businesses has stabilized the economy and slowed the economic contraction.  While job losses, foreclosures, and tight credit continue to plague many people, conditions have improved and the economy has been pulled back from the precipice, at least for now.