It is hard not to know something, if anything, about the financial crisis hitting Wall Street, U.S. politics, and your parents wallets recently. Yet, as undergraduate students trying to juggle our academic, social, and budding professional lives, it is understandable that most of us, and the American public, remain relatively uninformed on the nature of the crisis. There are, of course, different perspectives as to what caused the crisis and what should be done about it, but most, if not all, will look towards the sub-prime lending and adjustable-rate mortgage (ARM) “meltdown” when discussing the recent collapse of some the world’s largest financial giants.

The ARM crisis traces back to the end of the Clinton presidency and the early years of the 21st Century. To describe the origins of this hot topic I’ll use my hometown as a very imperfect example. A couple who wanted to buy a home in Wellesley, MA two decades ago would have gone to Wellesley Cooperative Bank, a small local bank with just two branches, both in the town. There, the couple would meet with a representative who would take a look at their credit history, job history, and current financial situation. The bank representative would help the couple understand their finances and ultimately decide whether or not he thought the couple could afford the house and pay the monthly principal and interest on the mortgage. Once the couple obtained the mortgage from the bank, they could buy the house and begin paying off their 30-year loan in monthly amounts to Wellesley Cooperative Bank (which would profit from the interest).

This process changed around the turn of the century. Wellesley Cooperative Bank was then approached by larger financial entities like Fannie Mae, who would buy that couple’s entire mortgage for a lump sum of money. Wellesley Co-op would turn and use that money to finance another mortgage to a different couple, and turn around and sell that to Fannie Mae as well. Now the original couple is sending their monthly payments to Fannie Mae; it is the exact same mortgage, just now owned by a huge national banking institution. Fannie Mae effectively enabled the local bank to finance countless extra loans by giving a percentage of that 30 year profit immediately, leading to better profits for everyone and more loans for the American people.

So what was so bad about all this? It certainly seemed great at the time, and since everyone from Fannie Mae to the small-town folk were either getting lots of easy money or reaping huge profits, no one questioned the system. But Wellesley Cooperative was faced with a slightly different problem. The extra money from selling mortgages to Fannie Mae needed to be invested or lent to more couples wanting to buy a house, but selling mortgages was an easier investment tool compared to buying stocks. But the larger institutions were competing for the wealthy borrowers, with great jobs and credit histories. Wellesley Co-op had to lower its credit standards in order to find more borrowers. This is where the sub-prime lending crisis began. Before, the local bank would only lend money to people they thought were able to pay the loan back. But since Fannie Mae was buying up all these mortgages, Wellesley Co-op faced no risk because they could sell the sub-prime mortgage off to the big national banks. A sub-prime mortgage describes a “risky loan” on the part of the bank to someone who doesn’t meet normal lending standards. To compensate the bank for taking that risk, sub-prime mortgages are characterized by high interest rates and lots of profit for the bank if the mortgage is successfully paid off.

But Americans are no less greedy than bankers or Wall Street and no one wants to hear that they will have to pay exorbitant interest rates on their loan if they want to buy a house. Thus began adjustable-rate mortgages and the beginning of the end for Fannie Mae and Freddie Mac. These types of mortgages would allow for a relatively low interest rate and small monthly bill for Americans who wanted to buy a house. The catch was that it was only appealing for the first four or five years of the mortgage. After that, interest rates would skyrocket and instead of paying $2,000 a month, the couple would get nailed with a bill hundreds of dollars more per month.

“But don’t worry about it!” the Wellesley Co-op representative would say, “because that $80,000 house you are buying is going to be worth $150,000 in five years!” When that happens all the couple would have to do is re-mortgage the house, giving them free money, five more years of breathing room, and the bank would get a new loan to collect from.

It turned out that the future was twice as good as anyone had previously thought. Americans found themselves sitting on houses worth half a million, or even a million dollars; ten times what they had originally paid for. So we kept refinancing those loans, banks kept rubber-stamping sub-prime mortgages and selling them off to the huge national banks who didn’t seem to know any better. Everyone was wealthy, and everyone was buying a house, until 2006 when the the value of houses stopped going up. Suddenly, people couldn’t refinance their troubles away. They soon entered the later stages of their mortgage agreement and payments began to rise. Houses foreclosed and since no one wants to live in neighborhoods with foreclosed houses, the values of surrounding houses dropped as well, leading to more foreclosures. The housing bubble had popped.

Meanwhile, Fannie Mae looked real good on paper. They owned lots of mortgages that they would be collecting on for years to come, but all the wealth was just paper. It was all imaginary. Just as the value of those houses was imaginary, the entire system was based upon the unfounded, yet a common belief that some random house was worth a lot of money. When the capacity of our imagination for greed was reached, the delusion of the housing market became all too clear. No one wanted to buy houses for that much money anymore. The people who bought those absurdly expensive houses were now getting them appraised for less than what they bought them for. When mainstream Wall Street and analysts came to their senses and realized these huge lending institutions were not actually as sound as they appeared on paper, stocks plummeted, rumors spread, and Bear Stearns, Fannie Mae and Freddie Mac collapsed. A combination of fear and financial problems soon led to the insolvency of the Lehman Brothers. Merrill Lynch, plagued with similar problems, some real and others imaginary quickly sought a buyout deal with Bank of America. AIG, believed to be on the brink of collapse, was “saved” by the Federal Reserve who bought 80% of the company’s stock and will oversee the dismantling of the corporation. And most recently, the second-largest remaining investment bank, Morgan Stanley, has been searching for a buyer amid declining stock and mounting fears.

Little doubt remains of how corruptly everyone from the largest Wall Street financial institutions to the small local banks has been behaving. While a specific sort of blame should fall on the CEOs who knew better, we must also recognize that everyone who profited from the easy money and imaginary wealth of the past two decades chose not to question, or even to inspect, the practices that were creating so much wealth and opportunity for all us. The crisis was predicted. There have been analysts and politicians warning about the problems that are now coming to fruition since the turn of the century. But no one cared to listen, nor do they now give these men their due recognition. The greatest problem we now face is allowing ourselves to believe that this problem is only a result of a few corrupt financial institutions. It is a symptom of the failure of our monetary system, which has been taken over by a group of unelected private officials in the Federal Reserve and supported by those the system benefits; namely, the CEOs of Wall Street. These are the individuals who have created the mess, and now with the help of Congress these are the same people who will continue to live a life of luxury at the expense of the American taxpayers.

Yet the problem has many faces. Too many to discuss in just one article, so I will break my opinion piece on the situation in two. This first one, to familiarize you with the side of the issue most discussed: the sub-prime mortgage “meltdown.” In the second, I will try to grasp the role of the Federal Reserve and our government throughout the past 30 years, and how Obama and McCain are reacting.

Photo by Flickr user Financial Aid Podcast used under a Creative Commons license.