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As I said in my previous post, the problem is a big story. It is complex, but there are major underlying principles.
The problem in the credit markets can be traced to overspending by the United States. Many of the dollars that build up overseas in the hands of foreign banks and investors have to find a place to go. Holders of surplus dollars understandly want their money to work for them while they hold it. Investment vehicles and interest rates in the United States have attracted lots of this money back to the United States for foreign investment purposes. Since there has been so much of it, holders of this money needed more and more places to position it to make it work for them. This in turn generated lots of money that could be lent out to borrows in the US. The more money that was available for loans, the more money got lent to less than desirable borrowers. Another factor was that lots of Americans who already had homes refinanced with some of this money, using their homes for "piggy banks" to pay for others things, some of which they really couldn't afford, and worse, to pay down credit card that got out of control. All of these people thought that the constantly increasing value of their homes would keep them ahead of the ball. Many of the sub-prime loans (money lent to people who no way could have gotten a loan 7 years ago) were made with low initial rates that had provisions for rate adjustment within a fairly short time. When the new rates go into effect, suddenly these people cannot come up with the additional $400-500 per month that their payment has gone up. The people who already owned homes and refinanced (sometimes several times) in many cases discovered that their property wasn't going up in value any more, or even declining. So, these people have a lot of debt on the books and no equity increase to look forward to in the foreseeable future.
Now the situation that I describe has happened to lots of people, but only a small percentage have defaulted so far. The problem is, it has happened enough to blow open the underlying weaknesses that have built up in lending practices over the past few years and this causes a lack of faith across the banking and investing system. Beyond that, many of these bad loans have yet to have the higher rates kick in, so there may follow many more defaults.
Remember when buying a house was a tough nut to crack? You had to have a down payment (which you had to save up for), and you had to have good credit which included a decent work history. These lending requirements have gotten lax in the past few years, but you didn't have to have a degree in economics to see that it was a temporary abberation. This kind of crazy lending was going to blow sky high and it did. Home ownership isn't a God-given right; it's something that has to be worked for. Not everyone is going to sit in his own house; some people are going to live in apartments until they die. Life isn't fair.
The problem that Et2ss mentions about inflating the money supply is one that shouldn't be overlooked. Discussion about the relative merits and weaknesses of the US Federal Reserve system would take a long time and is a subject that even the experts can never agree on.
If the population were to remain static, then we could determine what a reasonable supply of money might be and stick with it, like in the Monopoly Game. Since the population isn't static and is constantly growing, if the money supply were static, we'd run short on it. Consequently, one of the roles of the Federal Reserve is to regulate this supply of currency, and to expand it when needed. Normally, the money supply is increased gradually over time to expand with the population. The trouble comes into the picture when the Federal Reserve expands the money supply for reasons other than normal growth. Like bailing investors out of risky and/or failed ventures. Or, by trying to inflate the money supply to keep up with out of control government spending.
In our recent liquidity crisis, the Federal Reserve (and some foreign central banks) pours many millions of dollars into the money supply to take the place of money that is locked up in failed credit ventures. So, the Federal Reserve in instances like this, is really functioning outside its original role in that it is manipulating the macro-economic situation to stave off disaster. One wonders how long and how many such disasters can be staved off. Bailing out the banking world and creating printing press money may lead to no good.
Going back to some kind of monetary system based on intrinsic value like gold or silver sounds good, particularly to the kind of people who we might find reading posts on this board. People who appreciate solid values of all kinds. The problem is, in my opinion, that easy borrowing and credit in the US have not only destroyed our currency, but they have destroyed the will of our citizenry (for the most part) to live within their means. People tend to want it now; people no longer want to work and save for something and buy it outright. Easy credit (for many years) has led to inflation that has run the values of things up so high that it's rarely possible to save for things in any case.
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