Since the birth of "Reaganomics", the government has been deregulating the financial sector of our economy. With this new power to reign free, Wall Street gave rise to large financial firms, also called investment banks. These firms are not like commercial banks; rather than accepting deposits and distributing money, these investments banks concentrate on issuing securities to its customers (individuals, corporations, and governments). Their main business is centered around issuing securities and insuring pension funds, hedge funds, etc.
Because they mainly focused on securities, financial firms handled the insurances behind most mortgage loans issued by commercial banks. When the deregulation faze was at its highest, many investment banks began to bundle these mortgage-backed securities to trade and sell to investors. After this trading proved to bring an impressive return, financial firms began to encourage banks to issue more mortgage loans so more trading could take place.
So, banks began issuing risky home loans to just about anyone. Rather than only granting mortgages to customers with good credit and a down payment, banks now allowed customers to take out mortgages to buy houses that were way out of their price range. Because these loans were much more volatile, the financial firms and investors collected even higher profits from them, and the investment banks grew larger and larger.
There was no reason to suspect system to collapse; housing prices continued to go up; therefore, everyone would eventually be able to pay back their loan (or the bank could repossess the house at a higher value). However, like we have all come to know, the housing bubble eventually busted, and the market plummeted.
Home owners across the country began to default on their loans, and banks began pull from the insurances set up in the investment banks. This immediate and sudden pull of money caused the financial firms to embark on a downward spiral, and, to kick things off, Lehman Brothers (one of the main investment banks) collapsed, causing mass panic on Wall Street. After more firms like AIG began showing signs of failure as well, everyone began to panic.
Because everything from home loans to pension funds is insured through these firms, their collapse would equal a global economic catastrophe. The federal government knew this. So, in an effort to prevent economic Armageddon, the government passed the Troubled Assets Relief Program (TARP), which provided a capital injection (aka free money) to investment banks to stop the bleeding and continue the flow of credit.
However, rather than using this capital injection to continue lending money, the investment banks used it to raise their management's salaries and issue historic bonuses to their employees. Rather than punishing the people who single handling made the economy tank, banks gave them raises, and the country slipped into the greatest economic recession since the Great Depression.
People are confused as to why the Occupy Wall Street protesters are so pissed at corporate banks. Let this be a reminder.
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