The Debt Crisis

One of the things saving us from a complete meltdown of the U.S. financial system may be the fact very few people understand what is happening.

I'm not trying to sound like a snob, it's just that the debt market can't be easily described - or distilled down to a simple number like the Dow Jones averages. In fact there is no debt market as such; there are dozens of different markets that are all interrelated.

Suffice to say the debt market is many times larger than the stock market and is the grease that keeps the economy moving from day to day. Problems in the stock market can be costly - but a company doesn't shut down because its stock is off 10%. On the other hand, problems in the debt market can make a company (or the Michigan student loan program, or even an entire nation) shut down virtually overnight.

The debt market has been exploited by Wall Street wizards to such a degree that no one really understands it any more. This has been done through the use of derivatives, futures, swaps and options that have nominal values in the trillions of dollars. The Federal Reserve bank has a group of PhD analysts trying to define all the potential failure modes and even they don't understand it.

The prevailing view is that the U.S. government can solve any financial crisis and is too big to fail.

Guess what: it's not true. If people lose confidence in the ability of a borrower (any borrower) to repay its debts, the whole game shuts down. overnight.

If you want to get into the depths of this. Spend some time at the Calculated Risk blog. They make even the most dense and arcane stuff at least somewhat understandable.