Gary,
in the IMF seminar talk by Nouriel Roubini that you linked to is very good. Look at this great description of what has gone on in the US subprime market and its effects:

you've created a financial system in which if you take out mortgages, the mortgage originator does not care: he or she maximizes volume and [gets higher] income. Then the bank originates the stuff and packages it in MBSs and then they get the fee and they shove it to the investment banks. And the investment banks tranch it in all the different tranches of CDO and then shove it to their final investors and the rating agencies give their blessings. You would think that the final investor is the one who has to provide the market discipline but after four stages you do not even know what it is, and after CDOs you have CDOs of CDOs, and CDOs of CDOs of CDOs...

And this:

Of course there is an element of greed. At some point people were searching for yields or they should have known better, so I cannot just blame the rating agencies. But you have a whole system in which essentially people were making income not from bearing the credit risk but essentially transferring it somewhere else and getting the fees, and in most of the financial system that is how it gets its profit these days, so there is a fundamental kind of problem. On top of that the regulators [were] asleep at the wheel and let this stuff occur without any kind of constraint.

And then this:

We have lack of information about this stuff, about who is holding it. There is, as I said, more opacity and less transparency in financial markets. In this situation then once the trouble occurs and things are risky, then you have a situation in which you have lack of trust and confidence, you do not trust other financial institutions, you do not know who is holding the toxic waste, and you have also the significant increase in at least perceived counterparty risk and even large institutions kind of worry about each other.

It's a great account of what has happened.

PS,
Paul Barry on the ABC's Four Corners Mortgage Meltdown programme has a good description on how subprime works:

The ticking time bomb at subprime is the ARM, the automatically resetting mortgage, or, exploding ARMS as some people call them. They start off a nice low rate to suck people in and then after two or three years reset with a dramatic increase in payments. They’ve been all the rage over the last two years and some two million of them are about to blow up,

He quotes an example of this increase in repayments.Henry Mitchell

Had plans to retire here. They sent a letter to me about a week prior to that payment due in April that it would escalate, you know, from like 8.4 to almost 13 per cent and that would be almost $1000 more... I just didn’t have the money in my budget then on my pension, retired and then on, getting social security I just didn’t have any extra money.

Paul Barry says that Henry Mitchell should have known he’d be paying more, but he could have had no idea it would be so much. And his broker certainly never told him. He now has a court order for possession of the house and he’ll be evicted any day unless his lawyer can save him.

Gary,
I watched the Mortgage Meltdown programme on the ABC on Monday night. It made so much sense as it pulled the varrious threads together.

As Paul Barry says the mortgage meltdown in California and Cleveland spreads to shake the world because it was the big banks and brokers on Wall St who put up the massive amounts of money that fuelled the huge lending surge.

The dodgy loans then came back to Wall Street to be parcelled up into mortgage backed securities and collateralised debt obligations and sold to investors all around the world, with everyone picking up fat fees along the way.

its called playing hot potato:--- people, starting from the mortgage broker, take a fee and pass on the dodgy mortgage as quickly as possible. The mortgage brokers are basically defrauding their customers, mostly poor white and poor black Americans. The mortgage brokers are predators.

Nan,
It's the global links that are the next piece of the jigsaw puzzle.The web of transactions in global finance and capital flows have meant that people from all round the world have invested in the US. As Satyajit Das, the author of Traders Guns and Money says:

To give you an idea of global capital flows, 85 per cent of capital flows from Europe, the Middle East, and the Far East is in to the US. And a good chunk of that has gone into the subprime mortgage area, or the mortgage area in general.

So the money comes from overseas and it then gets lent out to people in Cleveland, Ohio.When the people in Cleveland, Ohio, default, the credit crunch wave comes back again outwards.

Several municipal councils in Australia have lost millions on subprime investments. Then we had the recent panic around the Adelaide Bank in South Australia, as it was feared that they had invested in Wall St's mortgage backed securities and collateralised debt obligations (CDO's), which were now next to worthless.

Gary,
I knew a trader once. They sure are different to us to naifs. Their's is a world of quantitative finance models--- the idealized models one sees in textbooks of many business schools and economics departments. They are interested in money not in ideas, analyze profitable games of chance, and they feel that the odds are stacked in their favor.

A portrait of someone trading in catastrophe bonds---nature's casino!

Gary,
the next piece of the jigsaw puzzle is the financial institutions dealing with the losses in a situation of a credit crunch. The hedge funds have been big buyers of credit derivatives.

Econophysics Blog says that:

In virtually every market crash (bursting of asset pricing bubbles)... investors, banks, etc., are compelled to sell assets in order to limit losses and/or hedge risk. The problem is that this is either hard to do and/or makes things even worse. Obviously, they want to get rid of non-performing and/or illiquid assets, but they can't right now (if ever) because they're heading toward worthlessness.

So they have to sell off 'good' assets, which means that prices of assets that at first blush seems to have little to do with CDOs, MBSs, mortgages, lending, banking, etc., also fall precipitously. i.e., correlations are created when there was little or none before!

Nan
Satyajit Das, in his Traders Guns and Money, describes the traders well.

He says that traders are the fly boys who sell the derivatives to investors, make huge bonuses, and then change companies before the repercussions catch up with them. The traders make fortunes selling derivative products, mask problems, and regularly moved to different companies after they got their annual bonus.

The long nature of some derivatives often meant the trader would have changed jobs several times before the consequences of the derivative came back to the bank the trader worked for when he sold it.

This meant the trader got his bonus, but rarely did the bank or the investor come out of the transaction so well.

So you can speak of the "rational madness" of financial derivatives markets since greed and fear of missing out on prrofit that underlies the derivatives game.

Wow, meaty stuff. Thanks all, could be chewing over this for days.
Tell me if I'm wrong. The interest rate reduction is like feeding metho, heroin or coke to an addict. Secondly, we have a good opportunity for "public debt; private gain". Three, it's all pyramid selling on a giant scale. Four, underlying this is a massive bout of casino capitalism up and running involving derivative "products", set to sting also the smarter capitalists who have to "play" too, or lose out to those who make a quick and substantial kill at the "casino".
Five, the rest of the world must continue to feed the US extravagance because the US has the weaponary to eventually go to war if given the excuse when cornered, at last resort
Must remark incidentally, in closing, at how much the Queen of Spades in the cartoon resembles Julie Bishop.

And yet today I've seen ads from a prominent nation wide lender for 'lo-doc', even 'no-doc' mortgages clearly aimed at the fiscally challenged.

Ian,
The Age reports that credit card debt in Australia has topped $41 billion, with Australians paying 11.9 per cent of their disposable income on interest payments.

While debt to income increased in the June quarter, the ratio of debt to wealth — household assets — remained steady at 26.3 per cent. Is this the first signs of the long overdue slowdown in household borrowing

And you can guarantee that the banks and co will be sending out their usual pre xmas "Do you wish to increase your limit letters? Just sign here and it will be done automatically"
41 billion Wow! If the reports that people are using credit to stop from losing their homes are true and xmas coming it will be interesting to see how much this increases by February.