The history leading up to these current events is actively being spun by the political season's participants, to no good ends; fair evaluation's of that history are available, but generally will not be widely understood by the public. which is one of the reasons that the wisdom of the crowds can be unreliable in such circumstances). Instead, we are left with confused and suspicious interpretations of legitimate goals that were the basis for past community actions, and erosion of consumer confidence, which tends to further accelerate and exaggerate the effects of the above circumstances.

Financial markets understand how these factors, in combination with each other, can interact and escalate over time to produce effects which are much more serious than when considered individually. This was likely the basis of their calls for immediate action, even though the impacts of resulting actions may indeed be modest, and inadequate to address the real root causes. The situation recalls August 17th, 2007:

The day before, the Dow Jones industrial Average had crashed a whopping 387 points, nearly 3 percent. The previous night the Asian markets had plummeted, and by morning European markets were sinking by an even greater magnitude...

The Federal Reserve responded by injecting $19 billion into the banking system to keep it afloat and allowed short-term interest rates to float down. This followed the previous day's Fed injection of $24 billion. A fearful European Central Bank injected a whopping 240 billion euros during  the first stage of the crisis, believing the European banks were at serious risk. Yet by Tuesday of the following week, despite these infusions of emergency cash, the Dow continued to plummet - first by 207 points, then 167 the next day, then by 280 less than a week later. On Friday, August 17, a spooked Japanese stock market dropped by 874 points,  more than 5 percent. Most world markets seemed in a state of free fall. Bond markets were in turmoil as money,  distrustful of the private sector, poured further into Treasur bills...

A relatively minor development had mushroomed into something more, causing the U.S. stock market's value to decline by nearly 10 percent (before eventually recovering after the Federal Reserve cut interest rates). That amounts to a sudden, instant, nearly $2 trillion loss equal to nearly one-sixth the size of U.S. GDP (gross domestic product)...

None of this makes sense, I thought. The markets had  become hysterical over losses in the so-called subprime  market, the relatively small market of mortgages and  mortgage-related financial instruments tied to borrowers  with no credit histories or abysmal ones. But why a  near-global stock market meltdown and a collapse of lending  simply because of some mortgage foreclosures? After all, the  problem loans amounted to, at worst, $200 billion in  exposure in a global market worth hundreds of trillions...

As  Eric Jacobson of the Chicago research firm Morningstar put it,  'There are so many interconnections today between different parts of the market that otherwise seem so disparate.' But globalization fails to explain why, seemingly overnight, the financial markets appeared to split from  reality, and what the ensuing chaos means for our future.

- David Smick, in The World is Curved

For the average American, our current crisis is all too familiar; the Savings and Loan Crisis and the Long-Term Capital Management bailout occurred prior to the above situation, yet are recent enough for many to still remember them. Though the details of who will end up paying for such bailouts are poorly understood, in finance, most recognize the idea that leverage can work for you or against you.

Right now, the leverage which many pursued in purchasing their homes with low down payments on expensive assets no longer seems like such a great deal. The promise that new regulations are a long-term fix for situations like this is at best overly optimistic, and at worst, quite dangerous; one needs to look no further than Sarbanes-Oxley to realize the negative impacts that typical (and in particular, rushed) regulations can cause over time, often with questionable benefits. Warren Buffett's remarks on the limits of regulation are particularly relevant in this regard. People look fondly at FDR's policies as they fear the current situation. Yet they are likely unaware that FDR's policies prolonged the Great Depression by as much as 7 years.

Quoting Smick again:

Reversals seldom come in one cruel, visible,  planned policy blow. Instead, like death from a thousand cuts, they come from a series of small, seemingly benign, but  dangerously destabilizing changes that reach a terrifying tipping point of market uncertainty and fear. That is what  happened during the subprime crisis, and today we are increasingly at risk of further financial calamities that  threaten a vicious spiral of destruction and heartache.

The clouds of concern about such a financial crisis were raised as early as 2003, yet real action was not taken at that time (possibly due to biased oversight, though there's plenty of blame to spread around). Still others claim this crisis goes back to the days of 1997, when the Community Reinvestment Act mandated offering loans to individuals who were not credit-worthy, though there is legitimate debate on that point as well. Some have also claimed that the Gramm-Leach-Bliley Act itself led to the housing bubble which, now burst, is a contributing factor to this crisis. This view has by now been largely discredited, even though it remains a dominant theme in political campaigns (where it's at times difficult to keep track of who is supposed to be saying what). The dynamics of this do not collapse well into brief sound bites; as in all things, it is difficult to separate out one single cause, when in fact a series of factors contributed.  But if one believes that what caused the US banking crisis is underregulation, why are seeing bailouts needed in places much more regulated than the US (for example, Iceland, Germany, and elsewhere in the European Union)?

Still others argue instead that it is not even possible to anticipate the risk of such events, and suggest that outcomes of such interactions are the variation that leads to winners and losers operating in a global marketplace. If you don't want losers, you better accept that we will then have far fewer winners. Quoting Smick again:

Financial markets have always operated on inequalities of information and analysis. You think or know A. I think or know B. But today's policymakers and market traders must depend more than ever on their gut instincts. The playing field is bigger, the stakes are higher, and the system,  because of its size and complexity, is unbelievably fragile. It is a house of cards that could come tumbling down for any number of reasons. That won't necessarily happen, but politicians and policymakers need to be careful. They need to  start caring about things that never much mattered to them before...

Most people today lack a historical perspective. The boom period is being taken for granted. Median-age American voters today were born in the mid-1960s. They have no recollection of the stagflation and long gas lines of  the 1970s, the period before today's globalized economy.  They have never known anything but a highly productive economy, with impressive stock markets and ample jobs...

To top it all off, policymakers don't appreciate the fragile nature of today's global financial system and how financially induced prosperity can stealthily slip away through the unintended consequences of well-intentioned policy actions that attempt to legislate or regulate economic security. Today, we find ourselves in a situation in which the globalized financial system both enables and threatens our national well-being.

And that is quoting a former advisor of Bill Bradley, who was hardly a free-market conservative!

Prophets of doom are rarely heard and acted on regarding systemic risks, before such disasters occur, especially when their world views are incongruent with conventional wisdom and mental models operating at the time. Such crises occur far more frequently than you might think (42 times and counting), yet responses are rarely proactive, and often result in unintended (and more serious) consequences.  In the case of the current crisis, one person has been ringing the bell about the current situation for some time. For the last two years, Nouriel Roubini, an economics professor at NYU, has been predicting the dramatic events of the last several weeks as they appear to be playing out in world-wide financial markets, yet few have been listening. In particular, Roubini outlined the following 'nightmare scenario', long before the 2008 financial crisis began to unfold. The scenario he envisioned would play out like this:

1. The economy enters a recession
2. Impacts from reckless lending practices (e.g. subprime lending, No Income No Asset loans, etc) spread throughout the economy
3. A sharp increase occurs in defaults of unsecured consumer debt (credit cards, etc)
4. Monoline insurance downgrades lead to additional writedowns by financial institutions
5. The commercial real estate loan market enters a meltdown similar to what occured for home mortgages
6. Large regional and national banks file for bankrupcy
7. Loan syndication and securitization options become limited across institions, due to lack of transparency of toxic waste
8. Corporate defaults accelerate (note that the rates of these have been lower than average, so increases should already be expected)
9. The shadow banking system's screen of default credit swaps collapses
10. Stock markets world-wide begin to price a sharp global economic slowdown
11. The credit crunch leads to a drying up of liquidity in financial markets.
12. The previous points compound in a downward spiral of losses, capital reduction, credit contraction, forced liquidation, and fire sales of assets below fundamental prices. This results further in a lack of trust in financial system participants - driven by the opacity and lack of transparency in financial markets, and uncertainty about the potential size of the losses and who is holding the toxic waste securities - which further accelerates and exagerates the impotence of monetary policy and further hoarding of liquidity.

Note that these elements are already in play within our current situation. In such a complex environment, while the potential risks are recognized, it may not be evident where the best leverage is in order to act, especially when fears, beliefs, and expectations play such a powerful role, and can in fact devolve collectively into the stupidity of crowds, especially in the harsh exchanges of a political season. But for the record, this train wreck began to manifest itself in facts and data as increases in home prices peaked in the second quarter of 2006, and a precipitous increase in foreclosures began to rise in the very next quarter of 2006... a long time before much attention was directed to these problems.