Spending the day watching CNBC, it's really quite stunning that they're unable to grapple with the real problem underlying all of this instead of the consequences of that problem. There's been a tremendous evaporation of housing wealth as a consequence of the bursting of the housing bubble. Lots of banks made bad loans and that money isn't coming back. Dealing with home foreclosures is time consuming and expensive and a lot of houses are underwater. Other people lost money insuring mortgages. Still more people lost money buying up those mortgages. Still more people lost money lending to people to buy up more mortgages. Even more people lost money insuring those loans. Etc.
All of this babble about liquidity and short selling and blah blah blah just obfuscates all of this. A big reason that there is a liquidity problem is that... people lost a lot of money. All gone!
And the last two words are the key - ALL GONE -
When the housing bubble burst, it erased a lot of the assumed value that was backing these various types of paper, and that is all gone.