The Market Chaos

How could something so small — delinquent subprime mortgages, which account for less than 2% of U.S. mortgage lending — trigger a financial meltdown so severe that it drove the formerly thriving stock market down 10%, sharply tightened credit for both homeowners and businesses, and even scared the Federal Reserve?

Little by little, the factors that contributed to the fall are becoming clearer, even if the relationship among them is not fully understood.

Much of the disaster has to do with the way those shaky mortgages were turned into complex investments and sold to banks, hedge funds and other institutions, here and abroad. As the risks of those securities became clear and their value fell, their owners were squeezed, particularly if they'd bought the securities with borrowed money to amplify their potential profits. To raise cash to cover their losses, they sold off unrelated investments, notably stocks. Markets tumbled.

The Fed — which had minimized the threat until the crisis began to unfold — began pumping liquidity into the system and on Friday cut the interest rate on the money it lends directly to banks. Whether the threat is now contained or will spread deeper into the economy is, for now, guesswork. What seems clearer is that these complex investment strategies are creating greater risks than was generally recognized.

[Excerpt of USAToday Opinion]