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You ask a great question and no you are not at all stupid for asking it.
The answer is rather complex, in fact there are books written about this situation, and of course you can turn on the TV and here a lot of talking heads yelling at each other about whose fault it is, the answer though is the one no one has the guts to admit-everyone.
I will try give you a fair assessment in broad strokes
If you really want to understand the current malaise you have to go back into history a bit, to the late 70's to a well intentioned law called the Community Reinvestment Act. The purpose of this law was to help disadvantaged minorities take the first step into home ownership. This rule allowed banks to relax some credit requirements for lower income folks. Banks knew of course they would risk higher defaults but could absorb those losses relative to the rest of their portfolios.
Over the next decades the government began pushing the idea of having as many homeowners as possible. It was thought that homeownership could provide family stability and reduce poverty. So over time more programs were developed to help people achieve homeownership. Traditionally one established equality by putting 20% up front. Those requirements were relaxed based on the idea that homes increase in value over time anyway.
In this scheme however banks ran into limits that were set in place a long time ago. Back in the thirties, in an effort to protect society from “bank panics” rules were established that required banks to maintain a certain amount of deposits versus the amount of money outstanding. That means banks were limited to how many loans they could have outstanding, enter “Freddy” and his sister “Fannie”
The quasi-private, government backed mortgage brokers, Fannie May and Freddy Mac, bought mortgages off of banks and resold them to others. The idea was to free banks to continue to make more loans.
This processed worked well for many years, homes went up in value, more people became home buyers, and the banks prospered off the origination fees and loan officers moved well into the upper middle class. As with many things too much of a good thing, turns into a bad thing. In 2000 Congress passed and then President Clinton signed off on a repeal of the Glass-Stegal act. This law was a child of the Great Depression that placed a wall between “Investment Banks” and “Commercial Banks” Now we have the stage set for a disaster.
Some bright boys on Wall Street got the idea of putting these sold mortgages into pools, and selling them as packaged investments. Thanks to the repeal of Glass Stegal, this was now a possibility. And so the securitized investment was born and people operating on the Street were very happy. The problem was that more fuel was needed for the fire, ie more mortgages to sell. So banks began devising all sorts of “exotic” mortgage products to get people into houses and home loans, that frankly should never had them. Zero down payments, weird payment schemes, ARMs etc… drove these products, home ownership got to an all time high, but that ownership came at a price.
The Street kept betting on these mortgages, you see as the home values went up, the value of the colaterized notes increased and banks like Goldman Sachs, and others, made out like bandits. The banks were making hand over fist in the processing fees and selling the mortgages at a premium and loan officers working on commission were buying beach house. Banks had the attitude that “hey we know a bunch of these are going to go bad eventually but we will make it up in all these profits”.
Much like anything else based on hot air and speculation, the bubble had to burst at some point. When the economy slowed down in 2008 (which it does about every 7 or 8 years regardless of who is in office) People began losing jobs, unlike in past recessions, though many more people had mortgages on their backs, they could no longer afford, and the defaults began coming in.
The result set off a chain reaction, as suddenly foreclosures rose, home values dropped and bank portfolios collapsed. The securitized funds imploded and all those who heavily bet on them, lost their shirts.
Banks were suddenly at risk and a few actually went under. Panic ensued and suddenly banks had to greatly tighten their credit, which made it difficult for small business to continue to get operating loans, the ripple effect of all this magnified by just how interconnected everything had become.
The above is the very short and shallow version, there is much more to the story, but I think I covered the basics.
Governments cannot “fix” the economy.. The best that government can do is to create a friendly environment for investment and expansion. The Economy is an article of faith, people have to be confident that their investments will yield results and until that confidence is restored; our economy will continue to struggle.
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