Leave the finger pointing, the who did what and the blame games asides for a second. It doesn't matter how the collective greed brewed this financial mess. The issue is pretty simple. People who could afford mortgage payments on their homes, walked away from them for a variety of reasons - loss of employment, sudden increase in the monthly payments (following the end of their adjustable rate term), or for something as cold and calculated as, better business sense (money already poured into the house by means of down payment and monthly installments not adding up to the equity built on it, because of the real estate collapse, at which time it becomes a negative investment, like, investing $100 to get a $50 return). This collective abnegation of financial responsibilities by a small percentage of home owners (as per the reports last year, as less as 8%) held the whole system all over the world at ransom. That means, no monthly payments coming in on the loans made out by the banks (causing them to foreclose the loan and assume the responsibility of selling it in the future, and till then incur maintenance expenses), no dividends going out on the investments made by the public (and other institutions) who bought those loans that are packaged are securities, and no payments by the insurance companies who insured those securities (meaning, if the loan is defaulted by the borrower, the insurance company would make the payments, just like any other policy). The crisis successfully managed to create an economic gridlock - nothing coming in, nothing going out, and the active players staying put, either because of fear, or just playing the wait game. The net result is capital crunch. All the imaginary wealth created during the real estate bubble vanished in the valuation magic trick, and the ones (banks) that have real money (cash) refuse to lend it out, lest it too disappears in the financial black hole. So, there, that, in short, is where it stands, as the whole world is crying in unison SHOW ME THE MONEY!
The issue, though fostered and fanned by them, is beyond even the far reach of the banks. It is time for the Big Brother, the government, to step in and try to stem the hemorrhage first and infuse some life in the moribund system. It is a common misconception that the government 'owns' the money in its coffers and it is its to spend any which way it likes. Like any other institution (well, any other non-profit institution), it receives money and it spends money. The annual budget lays out in great detail the ways and means of its spending. So in a crisis like this, how can the government intervene when it has a fixed revenue (assuming no new taxes) and fixed costs? Like it is with everyone else looking for some extra cash at the end of the month to meet the obligations, government depends on borrowing - from its own citizens and from the international community - by issuing what are known as treasury securities. To put it simply, people loan the government a certain amount of money (for which the government writes a promissory note, of sorts), which it repays after an agreed upon term with interest. Treasury bills, bonds and securities are the most popular ways governments all over the world raise cash to fund their projects (war efforts, infrastructure improvement etc). Obviously credit worthiness of the borrower pays a major role. After all, why would anyone want to lend a known defaulter/bad borrower who doesn't keep his promises and his end of the payment deal? It is here that the solidity of the economy (the capitalist fundamentals of the economy) and the stability of the political setup are looked at, and for countries like US with virtually no political turmoil and non-existent security threats, investors don't even bat an eyelid before lapping up the government bonds.
But these are unusual times, and this is no ordinary crisis. For the kind of massive infusion that the government is looking for to defibrillate the economy to its senses, a few wealthy individuals with a few millions to spare buying up the treasuries alone, isn't just enough. The issue has gotten way too big for the millions and billions. Only trillions can come to the rescue. And who, not individuals, not foreign governments, would have that kind of spare cash lying around? As a matter of fact, no one, not even the usually uber-wealthy states in the oil rich lands, would have (and want to loan) those kinds of numbers. Enter the Federal Reserve (the institution that, among other things, is entrusted with keeping an eye on the cash flow in the country) steps in and PRINTS those trillions of dollars in paper money. It then uses that money to buy up those treasuries, which has the same effect of handing the government the cash its needs. The government then pumps that money into the economy through a variety of ways - taking up infrastructure projects (which is the fastest way to create jobs), taking the bad debts off the banks' books by buying those toxic mortgages, tax cuts to the people and the companies etc. However this new infusion into the system is not without any serious ramifications.
Inflation. In its simplest definition, inflation is a situation where there is more money chasing fewer goods. If at one point of time, there are $100 in the market, say with 2 people $50 a piece, trying to buy a TV, and after the tax cut, 4 more got $50 a piece, trying to buy the same TV, the demand and supply law states that the price of the TV shoot up. The immediate fall out of more money in the system in the reactionary rise in the prices. Everyone has more money for the same amount of goods. But since the market is suffering with the 'cash-strap' bacteria, the antidote of infusion would first get the economy on its legs. Inflation, at this stage is a welcome headache, but in fact is another battle for another day. But there is also an unwanted side-effect with more cash in the system - devaluation of the currency.
Currency, in the international markets, is traded just like any other commodity. And the value of it (usually with respect to other standard currencies as Euro, British Pounds, Swiss Francs etc) is backed by the vitality of the country's economy, meaning, if the US economy is sound stable and humming along nicely, people would like to stock up on the dollars, since the purchasing power of the dollar is more. But if the flood of the currency causes the prices to go up, it simply means it takes more money now, than it had before, to purchase the same commodity, which in turn spurns the prices of the imports, which again impacts the prices of the commodities, and the situation would soon spiral to its eventual doom (much like how the system in Zimbabwe has been decimated by thoughtless and mindless printing of more currency (it even has a billion dollar note)). So the tight rope walk of the government (and the Federal Reserve) remains deciding when to pull back all the extra cash in the system, without triggering another cash collapse. Since the first order of duty is to get the economy humming, let's restrict our scope to pre-inflation measures.
OK. So the government has got its trillions in its coffers handed down by the Federal Reserve. Now what? There are varying schools of thought here as to what constitutes the fastest way of jump starting the troubled economy. 1. the simplest - hand out an equal share of the total amount to each resident of the country and let them pour it back in the economy (in the process, by paying off some of their debt) and unleashing the collective purchasing power of colossal proportions. 2. the most convoluted - buy all the toxic mortgages from the banks, that locked up the system, by plunking down the cash, thus making the cash readily available to the banks to start lending once again, greasing up the system and resuscitating it back to life, in a top-down approach. And all the bad mortgages that the government bought would be sold back to the banks at a later point of time (hopefully for a tidy profit), when the economy turns around, and the values of the homes are back to decent levels. And if everything works as per the plan, the government pays back the Federal Reserve, effectively pulling back all that printed cash out of circulation, staving off inflation and devaluation at just the right time. In short, the immediate financial future of the country (and the world) hinges on that one conditional - IF everything works as per the plan.
To Krishna Devaraya's court came 3 brothers one day with a unique problem in their inheritance will. Their father decreed that the 17 elephants in their heirloom be divided in such a way that the elder gets half of the total, the middle gets a third and the last, a third of the second's. Obviously the individual fractions do not add up 1, and the animals were not to be sliced up (and killed) as per the will. A tough problem. Enter Tenali Ramakrishna with his inimitable wit. He adds another elephant from the king's stable to the equation, making it 18 in all. The first one's share - 1/2 = 9, the second one's - 1/3 - 6, and the third's - 1/3rd of the second - 2. 17 divided though not evenly, but humanely, and the king's elephant goes back to the stable. Problem solved. Hopefully, same is expected with the Federal Reserve and its trillions. Cash comes out, solves the crises, and cash goes back in.
That is the funny and frustrating part with the economy. As much as the experts try to force their theories as next to salvation, the truth is, NOBODY KNOWS - no one knows whether it would work, or wouldn't, and if doesn't work, what next? There are way too many moving parts in this complex global financial machine, that probability and predictability of an outcome is near impossibility. Just as the experts don't know why something didn't work, despite everything going for it, they don't have a slightest clue why something worked, when it worked. Every situation, meltdown, crisis, has its set of variables, conditions and platforms, that trying to learn from it in order to predict/avoid a future collapse is an exercise in futility. It is like that philosopher's saying - you can't take a dip in the same river twice, meaning at every unit of time, a new variable is introduced into the system changing some/whole complexion of the game. No two crises are (will ever be) the same, and consequently, the lessons learned from them, as history showed over and over again, are purely for academic purposes. The current financial experts quote the example of the Great Depression of 1929, when the Federal government simply stood aside and did nothing, as the unregulated market and the banking industry went down in flames, and it took a good 6 years to recover from it. Now, with the government so deeply involved in the mess and committed to turning the tide around, only history will decide if this indeed the cure for such ills, not just the dressing/treatment. As they say, peace is just a brief respite between two wars. May be, prosperity too might be a passing phase between two meltdowns. Like everyone and everything, who knows?