How is this problem causing so much financial difficulty for banks and investment companies?
— Jason Burt, Maple Valley, Wash. It’s true that housing altogether makes up only 5 percent of the economy. Subprime mortgages are a much smaller chunk of that, and those in danger of default an even smaller percentage. But one of the explanations is something called leverage, Davidson explains. Here’s how it works: Big banks like Bear Stearns might have, say, $1 million, but they borrow $30 million and invest that in securities backed by the subprime mortgages. It’s a great way to make money if the market moves up, because you get $30 back for every dollar you make, Davidson says. But that can also work in reverse: If you’re in debt $30 for every $1 you own and the market goes down even the slightest bit, you’re in trouble. So why would banks put themselves in that position? It made sense a few years ago because housing prices on average across the economy had never gone down in the history of the United States, Davidson says. When that did happen, the banks were so exposed — and that
