I'm no expert on matters economic, but I've been doing some reading recently, when I need to take a break from writing my thesis. I set out to try to find an answer to "how the heck did this happen??" While the complete history of the financial crisis has yet to be written, much of the commentary will likely revolve around the following:

1. Easy money for far too long ....

The fed dropped interest rates from 6.5% in mid-2000 to 1.75% at the end of 2001. By June of 2003, the rate had been cut to 1% where it remained for nearly a year.

Many would say the Fed had it right -- to insure against a Japan-style stagnation, interest rates needed to be low. Things were looking pretty good in 2001, with a mix of solid growth and low inflation, and talk of a "new economy" only served to bolster the Fed's case and polish the credentials of Fed Chairman Alan Greenspan.

However, while traditional measures of inflation looked tame, easy monetary conditions helped create and inflate one of the largest U.S. housing booms in history. Because the U.S. Consumer Price Index measures RENTS, not rising home values, the spike in housing over the first half of this decade was not captured in official statistics and was ignored by many at the Federal Reserve.

So, lower interest rates allowed homeowners to assume more debt, with the extra debt used to purchase even larger homes and loads of other consumer goods. Real estate became the darling of investors, and the more home prices soared, the more households used their homes as ATMs -- extracting more equity while going deeper into debt. Simultaneously, the availability and popularity of subprime and Alternative-A mortgages skyrocketed, rising to 40% of the total U.S. mortgage originations in 2006 vs a share of roughly 10% in 2002, and further inflating the housing bubble.

2. Technological advances that helped spread loans, capital and risk ...

Typically a virtue, technology became a vice that helped spark and spread the global financial crisis. In particular, the use of technology and innovation increased the velocity and volume of loans to home owners.

Technology also allowed the rapid spread of these new products to all corners of the globe, so when the U.S. housing bubble burst, and delinquent loans related to U.S. subprime borrowing started to rise in early 2007, the effect was felt not only on Wall Street but around the world. The impact has been severe in Europe, where the region's banks have written off more than $200 billion in bad loans in the past two years.

3. A lax regulatory environment combined with benign neglect

The jury is still out when it comes to regulatory oversight (or the lack thereof) and the role U.S. rating agencies played in allowing the spread of bad loans and high-risk securitized debt (see below). Undoubtedly, the debate on Capitol Hill will continue for some time as regulators and legislators assess how and why such a large, unregulated, so-called "shadow" banking sector emerged in the U.S.

More certain is this: there was a collective failure in establishing an effective regulatory framework in connection with originating mortgages, the spread of derivatives and other securities, notably credit default swaps and collateralized debt obligations. Little oversight, the lack of transparency, a general sense of complacency -- all of these variables played a role in creating a regulatory environment that fostered excessive risk taking by various financial players.

4. The securitization of debt ....

Greenspan noted that "innovation and structural change in the financial services industry have been critical in providing expanded access to credit for the vast majority of consumers." "Structural change" was certainly a key factor in sowing the seeds of the financial crisis. What changed, in particular, were the ways banks and financial institutions packaged and sold complex securities like derivatives, collateralized debt obligations, credit default swaps and other instruments to investors all over the world. The securitization of debt was instrumental in triggering the explosion in leverage and debt over the past few years, fueling ever rising levels of risk-taking and debt obligations at home and overseas.

5. Excess U.S. spending ...

While many Americans are furious with U.S. banks, regulators and legislators for the damage wrought by the financial crisis of the past 18 months, U.S. households played a leading role in perpetuating and deepening the crisis. By saving too little while spending and borrowing too much over most of the past few decades, consumers have done their part in creating the mountain of leverage that now overhangs the U.S. economy.

Between 1992 and 2005, the financial balance of U.S. households swung from 3.7% of GDP to -3.6% of GDP. Behind this swing was a sharp decline in the U.S. personal savings rate and huge borrowing related to the U.S. housing boom, factors that encouraged excessive borrowing to purchase homes and a surge in mortgage equity withdrawals. The home equity loans that allowed consumers to tap into their homes' value to purchase trips, technology toys, and to a lesser extent home improvements, ended up both devaluing their homes, and sinking the economy further into debt.

6. Global savings glut ....

While the current global financial crisis was largely "Made in America," the United States is not the only party at fault. Also culpable are the excess saving nations of Asia (think China and Japan), where the penchant for "exchange rate protectionism" over the past decade created a massive reserve of excess capital. Over the balance of this decade, this excess savings -- dubbed by the Fed as the global savings glut -- was recycled into U.S. securities. This abundance of cash helped keep U.S. interest rates low, which in turn fed the borrowing binge in the U.S. In other words, we borrowed from China and Japan in order to keep our interest rates low, leading to more debt all around.

The huge accumulation of foreign exchange reserves, by definition, represents a massive outflow of official capital. Asia was not the only source -- many nations in the MIddle East also exported excess savings to the U.S. Without this excess savings, it's unlikely the leverage in the U.S. would have built up to the epic proportions it ultimately reached. For the first time in our history, we have a huge chunk of U.S. holdings used as collateral for loans received from foreign investors. And given the current foreclosure climate, those U.S. holdings are at greater risk than ever.

In the end. all of the factors just mentioned -- many of which are interrelated and mutually reinforcing -- helped spawn one of the greatest credit booms and subsequent busts in financial history. Fixing the financial and regulatory system in the U.S. will take time and is likely to be a key challenge for the Obama administration. That being said, one thing is certain: a new global regulatory infrastructure is coming -- and it is likely to be the most sweeping change in decades. To set the U.S. economy on a firmer foundation, the U.S. needs to save more and consume less. And many parts of Asia, notably China, need to focus on domestic-led growth rather than export-led growth in order to rebalance global growth once and for all. In other words, while it might seem advantageous to invest heavily in the U.S., it would do China and other foreign investors more good to invest in their own economies. It wouldn't hurt the U.S., either, to reduce the amount of leverage to external entities.

We're not out of the woods, but it helps to understand how we got here in the first place.

Primary source: William Fleckenstein, "Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve," McGraw-Hill, 2008. ISBN 0071591583 -- this is the book that seemed to provide the best insight and explanation of the economic craziness of the past decade or two.