You may well be asking yourself, what the hell? How come the banks are getting trillions of dollars and they’re still broken? Didn’t I give them all my deposits and now my taxes? And the people with their hands on the spigot keep saying that if I don’t give them more they’ll collapse. Aren’t we trying to raise the dead?
WTF happened? Credit default swaps. $50 trillion notional value. $14 trillion U.S. 2008 GDP.
Just think of the financial system as a gigantic casino, kind of like the Sands before a wrecking ball knocked it down, where people bet against the house or on the house but the house burned down.
People bet even though they had no chips. Now the chips are down and they owe money to the bookies, aka "counterparties". But they have no money. But we do. Or rather, the Treasury and the Fed can keep printing money in the back room.
This entire betting area was unregulated, done in a dark alley. No one could see in and no one kept a record of his or her "contracts" or bets. A lot of the time they were made over the phone.
The reason these "agreements" were called credit default swaps: if they were called insurance, they would be regulated. No wagers without capital reserves to back them up in case of default. But people bet without any money in case of default. Or people bet without owning the underlying asset, as if someone could bet on your house burning down while you pay the premiums to the insurance company that couldn’t pay your claim.
No money put aside for a rainy day. Not enough rain to put out the fire.
When Lehman went bankrupt (or "was allowed to fail") all bets were off. Lehman owed money on bets against it and couldn’t pay off on bets it made. Shareholders were wiped out. Debt holders got pennies on the dollar. And credit froze. Investors were scared and still are. What if the government decides on a whim not to back up a failed bank/insurance company/commercial paper/money market fund? They’ll never get paid back. The banks don’t even trust each other.
No one can get money now unless it’s from the government and it’s a failed financial institution and it has well-paid lobbyists. Investment grade companies can’t borrow for less than 10% interest. Who can afford that kind of debt service? A lot of companies are being downgraded by the very credit rating agencies that slapped triple-A ratings on worthless paper.
What is the endgame?