Join me in a little thought experiment.

Seal a 100 dollar bill in an envelope, affix a price tag to the envelope, and write $110 on it.  Then put it up for sale, telling potential buyers that if they spend $110 on this envelope, they can turn around and sell it for more.  Don’t worry about what’s in it.

Somebody buys it, affixes a new price tag that says $125, and sells it to somebody else who also increases the price and turns it over.

This goes on for some time, with each new buyer swapping out the price tag.  Somewhere along the way, somebody gets the bright idea of putting 10 envelopes into a larger, fancier-looking envelope.  Why not make 10 times the profit in a single transaction, right?

And the party goes on.  The fancy envelopes beget pretty printed shoeboxes and the prices go up again.  Nevermind the party poopers screaming, “But what’s in the box?”  Nobody cares what’s in the boxes.  They must be valuable, right?  People keep paying more for them.

One day, the holder of a refrigerator-sized package wrapped in gold paper and sporting all manner of ribbons and bows tries to sell it for $100,000,000, and fails.  The lender who floated him the loan to buy the thing takes it back and decides to sell it at a loss just to get it off the books.

But the lender finds out that he can’t sell it at any price.  A lot of people have been having trouble selling their pretty boxes and envelopes.  Not only that, but lenders have a lot of money tied up in those pretty boxes, meaning they don’t have any money to lend for other purposes.

Desperate, the lenders start trying to sell their assets at ever-lower prices, trying to get something out of them.  But nobody’s buying.  Nobody wants a pretty box that he can’t resell at a higher price.

Finally, the lender finds a buyer who says that he’ll be happy to buy the box, provided he can open it beforehand to see what’s inside.  The lender reluctantly agrees and looks on as the potential buyer opens the box and pulls out 100 pretty shoeboxes.  Inside each shoebox there are 10 fancy envelopes, each of which contains 10 plain white envelopes holding a single hundred dollar bill each.  The lender’s $100,000,000 “asset” is worth $1,000,000.

My dad used that little parable (he called it the last sucker theory, but it’s more commonly known as the greater fool theory) to explain the events leading up to the savings and loan crisis in the late 1980s.  It’s equally apt in explaining much of the current financial meltdown, what with the mortgage backed securities that were “backed” by worthless mortgages, investment firms that were leveraging their investments 35-to-1, and all the while knowing that they were just riding the wave—hoping they weren’t the ones holding the box when somebody demanded that it be opened.