The initiating factor for the slowdown in the economy has been the fallout from the subprime mortgage industry and the resulting credit crunch due to higher than expected foreclosure rates.
But it would seem that more homeowners facing foreclosure should not cause such widespread repercussions throughout the banking industry; in other words, the effects seem to be greater than the cause.
The reasons for the credit crunch, though, are far more numerous just people falling behind on their mortgages.
Money is created primarily through the issuance of credit in the forms of mortgages, credit cards, business loans, and so on.
Banks are able to create this money out of thin air, based on how much other money they have on deposit which has also been created out of nothing.
As long as loans are being paid back over time, this money creation scheme can continue for long periods of time.
But the problem comes in when the principal for loans are created but not the interest.
Banks make money from collecting interest, but they only create the principal amount of the loans.
This leaves the entire economy with a vast shortfall between the money created through debt and the money needed to pay back the interest on all of this debt.
People who take out loans are forced to compete with each other to obtain as much money as they can in order to pay back the interest on the money they have previously borrowed but which had never been created.
The results of such a system are easy to predict: some homeowners will be able to gather enough money through production and pay off their debts in full.
Others, though, may engage in successive cycles of borrowing, refinancing their homes and taking out new loans to pay back old interest but never coming out ahead.
Eventually, some people who borrow money will find that they have not gathered enough of principal money from other borrowers and they will have no choice but to default on their debt.
Defaults are eventually written off by banks or the loans are discharged through bankruptcy proceedings, but the debts are eventually destroyed.
Banks, of course, plan for a certain amount of their loans to go bad or their borrowers to fall into bankruptcy.
It is a necessary cost of creating principal out of thin air but never issuing enough money for all of the interest to be paid back.
These loans, which the bank counts as assets because they were expecting to be paid back, are simply written off and the money is counted as destroyed.
Larger than expected defaults, however, cause larger than expected destruction of the money supply.
Following a huge increase in the money supply by giving loans to people who could not afford to pay them back on properties with inflated values, large destructions of the money supply can affect the lending industry as a whole.
The amount of money banks are able to lend depends on how much money they have in reserve.
If a large number of loans goes into default or foreclosure, bank reserves will shrink and the amount that banks can lend to homeowners or individuals or businesses will also shrink.
Coupled with the loss of confidence in the previous loans that had been made, banks will no longer even be willing to lend money to each other, let alone individuals or small businesses.
This is the resulting credit crunch as banks raise lending guidelines or refuse to create any new money as debt to circulate in the economy.
But without the creation of new money, a new threat is faced by both borrowers and lenders.
That is, even fewer people will be able to obtain the remaining money necessary to pay off their loans, and more bankruptcies and foreclosures will result from the credit crunch caused by the destruction of debt money from previous bankruptcies and foreclosures.
This is one reason that the credit markets have begun to freeze up, regardless of the central bank interest rate or money supply manipulations.
Banks created money for people who would never pay it back, and they have no choice now but to suffer the consequences of these decisions or hyperinflate the money supply by creating new loans in the hope that it will result in old loans being repaid.
In essence, the subprime mortgage experiment was a Ponzi scheme at its least thought out.
But now that both the people and the banking industry have grown accustomed to federal government and central bank bailouts, without a fundamental change in the monetary system, little can be done to help homeowners ever pay off their debts to the banks.