We've experienced some unprecedented events in our global finance system between August 2007 and the date of the writing of this FAQ page (3/10/2008). These are ...
1.) The subprime housing value pump was derailed.
2.) The Bears Stearns funds collapsing in August put every one notice that hedge funds can die.
3.) The corporate junk bond market froze solid.
4.) The asset backed corporate paper market froze solid.
5.) The municipal bond and investment grade corporate bond market froze solid.
Item #1 & #2
The housing boom was underwritten by something called an MBS - a mortgage backed security. These were created out of bundles of mortgages and passed around between large investors as if they were cash. Hedge funds bought them, treated them as cash, borrowed twenty to one based on the value of these "assets", then went around pumping the "value" of everything else in a buying spree that pretty much matched the duration of the Bush administration.
When the two Bear Stearns funds let go last August instead of having 100% of their face value they got liquidated for 10% of what people thought they had in them. Everyone who was watching knew the game was up at that point. Without the financial energy of the speculative hedge funds moving in the economy a lot of things were going to stop and this started hitting those who were least credit worthy first, which is how this is tied to the subprime mortgage mess.
Item #3
I don't know much about the junk bond market so I'm just putting this here as a placeholder. Junk bonds are not insured by monoline bond insurance agencies, which will become important just a little bit later in this page.
Item #4
Thirty five billion dollars worth of U.S. asset backed corporate paper (ABCP) was sold into Canada late last summer. These are bundles of car loans, credit card obligations, and the like. This was supposed to be a highly liquid investment with a bit of an interest rate - the sort of thing were you could get your money back in seventy two hours. The biggest Canadian pension fund has twenty billion dollars worth of this stuff and they've been trying to get their money out for the last seven months. Once this happened no one else with any real money was willing to buy this stuff. Word is the Canadians might get $0.10 back on the dollar, just like the hedge fund investors. That is important to note - risk level with supposed cash equivalents is equal to that of highly leveraged hedge funds.
Item #5
The monoline bond insurers, those guys who take a little cut from every bond issue and in turn insure the bond so it qualifies as a low risk, investment grade asset had got themselves into insuring the MBS, CDO, and other imaginary asset markets. The big three, AMBAC, MBIA, and FGIC are all insolvent now. They can't stand the hits that are already lined up and they had their funds in ... safe, conservative investments, just like those poor Canadian pensioners.
New York based AMBAC and MBIA have been ordered by the state insurance commission to get their houses in order or else. We will see some sort of splitting here - either they split themselves, or more likely Warren Buffet's company will start a bond insurer for municipals and leave the monolines holding the bag on these make believe assets. They probably don't have the assets needed to cover their obligations based on a normal bond failure rate and 2008 is absolutely not normal.
Why is this bad? All over the world pension funds hold tax free municipal bonds because they're "safe". When the monolines let go those bonds depend on nothing more but ... property tax revenues from municipalities under the gun due to the mortgage mess. They're no longer investment grade and the pension funds have to treat them as speculative assets, which generally means they get sold at fire sale prices. Yes, pension plan cuts will happen pretty much across the board for everyone.
Conclusion:
OK, got all that? This means J.P. Morgan, Chase Bank, Merril Lynch, Salomon Brothers, Goldman Sachs, Bank of America, Morgan Stanley, and all the rest of the big banks listed over at the Banking Implode-o-meter are going to move from the "distressed" column to the "imploded" column. Unemployment here will parallel the Great Depression only we're going to have a much harder time pulling out of it, as all of our manufacturing jobs got moved offshore a generation ago.