I'll give you my quick and dirty understanding, divided up in a few broad sections - housing crisis, mortgage crisis, investment banking. But FIRST, what it means for you. If you want a good media commentator on this, read Paul Krugman's columns in the NY Times. He's a giant in the economics world, he can write, and trade and economic crises are his particular specialty.
What it means for you
1) Businesses that depend on the housing industry are screwed. Businesses that need access to easy money or borrowed capital are hosed. Businesses that depend on importing stuff from the rest of the world are f*ck*d. Businesses that work on a cash basis, or who make stuff for export, are generally better off.
2) Rent, don't buy, until house prices reach a level where you could move out, then pay the mortgage by renting to someone else.
3) Avoid personal debt - credit cards, etc - like the plague.
Topic 1: Housing Prices
1) You can do two things with a house: you can rent it or live in it (and "pay rent to yourself" at the same time that you're buying the underlying asset).
2) The price of housing has been going up, partly because of low interest rates (so carrying a mortgage is easier) and low energy costs (so heating, power, and transportation are cheap, in turn partly caused by an overvalued USD.)
3) The other part is speculation, since, with low interest rates, housing became a "good investment" rather than a "place to live". Since the late 90's, people have been treating their houses as their retirement funds (!!!)
4) This cycle where low costs beget speculation, which begets more speculation, ratchets prices upwards.
5) Nationally, prices are now between 100% and 80% more than what would be supported by the prevailing local rental rate (historically, about 20x annual rent for an equivalent dwelling).
6) We no longer have the upwards pressure of low interest and energy costs causing the ratchet upwards, so the market is "correcting" itself.
Topic 2: Mortgage Crisis
1) Most people don't pay for real estate with cash. They take out a loan with a bank.
2) Rather than holding the mortgage, banks then packaged up mortgages and sold some of them as bonds, getting the value of their principal back and enabling them to make more loans, make more money, etc. They also keep some.
3) As the price of houses goes down, people are defaulting/being foreclosed on. This drives the value of the bond downwards, because the interest is no longer being paid AND the underlying asset can't be liquidated at nearly the price that it was "booked" at.
4) Nobody knows where the housing market's going to crater, so this uncertainty is being priced into the bonds, because no one wants to be the idiot who bought into a falling market and lost their shirt before lunch.
5) Accounting rules ("mark to market") state that the value of these bonds is the CURRENT selling price. So companies owning these bonds (including the depository banks themselves) are suddenly worth a whole lot less than they thought they were.
6) These rules also forced the Treasury to re-nationalize Freddie and Fannie. If Freddie or Fannie went under, they'd have to liquidate their assets, pushing a huge amount of bonds on the market, driving the price further down (since there's no ready money available to buy them up) and screwing everyone with any exposure to the market, even 2nd or 3rd hand (you own part of A, who owns part of B, who owns part of C ... if C goes under, A and B are screwed too).
7) In the example above, A, B, and C are all screwed because financial co's are "highly leveraged" - they owe and are owed a high multiple of what they hold in ready cash. So a small dip can turn into a major crisis, by wiping out the ready cash. (ie, if you have $1 in your pocket, are owed $10, and owe $10, you're a bank. If what you are owed is now worth $8.99, but you still owe $10, you're totally wiped out. This is why loan sharks are such happy-go-lucky, forgiving, genuinely nice people.)
Topic 3: Investment Banks
1) Investment banks (Bear Stearns, Merrill Lynch, Lehman etc) are regulated really differently than depository banks.
2) Investment banks have been chasing higher returns by betting the firm's money as well as the clients'.
3) When the value of the firm's assets drops, the value of the firm drops, and Merrill, Bear, Lehman were all caught in that kind of collapse. A public i-bank can't live for long with falling stock prices, because they'll lose all their clients, who have no desire to get screwed.
4) This is complicated by "counterparty risk" - if A makes a trade with B, and B goes under while the trade is pending, A might be screwed. That's why the treasury is involved, to make sure that the counterparties (and therefore the entire system) don't get screwed.
5) Like in 7) above, i-banks are highly leveraged. They're even more highly leveraged than depository banks. So they're extra-sensitive to (relatively) small fluctuations in the value of their assets.
Hope that this makes things a little easier to understand! It's tough. I suffered through 2 years of this stuff in b-school, and it's still tough to piece out.
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