The Causes Behind The Current Economic Climate: A Layman's Guide...

It seems now that everyone is aware that the world's economy is in a troubled state at the moment. And we're aware that much of this is due to the housing market.

Or at least, part of it is. There are a number of other factors, so let's take a moment to look at some of those...

1) After the .com boom, interest rates became attractively low, which lead people to buy more property rather than rent. This lead to property values increasing, and when people saw their houses double or triple in value in a few years, many decided to sell and purchase another place with a larger value, hoping to double or triple that as well.

2) Investors began to trade in mortgage-based assets. When someone takes out a mortgage, it becomes an asset to the bank, since they have income and profit generated by the mortgage. They can bundle mortgages together, and resell them as a financial product to the big movers and shakers in financial markets. The banks and investment companies also take out insurance policies on their investments to ensure they are covered in the case of loss.

3) The US (and other countries) loosened the limits on lending, allowing people to get mortgages that previously would not have been able to. In addition, mortgages became available in the US that allowed them to have a fixed-rate mortgage for a few years, which then changed to a variable one (adjustable rate mortgage, or ARM).

4) The housing bubble burst because the average house became to expensive for the average person to buy (never a good thing), and interest rates rose.

5) All those ARMs got to the end of the fixed rate periods, monthly repayments rose, and people began to default. In particular, as many people were in negative equity (the value of their house was less than their outstanding mortgage), some just stopped paying their mortgage. This meant they lost their home, and suffered the credit rating hit.

6) With defaulting, the value of the mortgage-based assets began to decline, and eventually became unsellable. Insurance companies paid out to cover the losses. Which is why investment banks and insurance companies (Lehman Bros and AIG) were some of the first big casualties of the current crisis.

7) Finally, with financial companies not able to trust each other to be stable, they began to withdraw inter-bank lending, and so many financial institutions that did not have a good retail front (ie, customers walking in the door with their salary) began to suffer - their investments were devaluing, they couldn't borrow more, and so on.

And so it went and here were are...

Banks toppling and being taken over every day. Insurance companies, investment companies, and other financial institutions struggling. Larger governments bailing out the central banks. Smaller governments applying to the International Monetary Fund for help. Recession being spoken about in real terms.

All from a few, simple mistakes.