First, a capsule analysis of the crisis.
1. It all starts with the bursting of the housing bubble. This has led to sharply increased rates of
default and foreclosure, which has led to large losses on mortgage-backed securities.
2. The losses in MBS, in turn, have left the financial system undercapitalized — doubly so, because levels of leverage that were previously considered acceptable are no longer OK.
3. The financial system, in its efforts to deleverage, is contracting credit, placing everyone who depends on credit under strain.
4. There’s also, to some extent, a vicious circle of deleveraging: as financial firms try to contract their balance sheets, they drive down the prices of assets, further reducing capital and forcing more deleveraging.
Starting with point #2 (I'll be returning to #1) let's unpack the language here. "The losses in mortgage-backed securities have left the financial system undercapitalized." Undercapitalized means short of cash. "...levels of leverage that were ... acceptable are no longer OK." leverage means borrowing or debt. Translation: we have too much debt and not enough cash. That's us - collectively, all of us. Sadly, we're all in this together.
Returning to point #1... Far be it from me to disagree with Paul Krugman, but it didn't start with the housing bubble. It started when we began to believe that it's acceptable to have more debt than cash. Even after the painful lessons of the 1930s, it was only ten short years before we began rewarding ourselves for the years of deprivation during World War II by turning to banks for mortgages for new homes. The Levittown housing boom was off and running. It was another ten short years before we began thinking, "Well, maybe if a home mortgage is okay, a car loan would be okay. After all, the car has value, too."
And then came credit cards. Yep. Just thirty short years after the worst credit crisis in history, came credit cards. At first they were loosely backed by bank accounts. I know this 'cause I had one of those first credit cards. I was seventeen years old when the bank where I had a checking and savings account sent me, unsolicited, a shiny new BankAmeriCard. Its credit limit was less than I had in my savings account. So, that was pretty safe. But, of course, as I used the credit card and paid the full balance every month, the bank increased the credit limit. By then I was a grad student. In those days, if you were smart and you worked hard enough, you could actually get through college and grad school without student loans.
It's been all downhill since then. And make no mistake about it, we're all in it together.