ARM stands for an adjustable-rate mortgage. Traditionally in the United States, homeowners used fixed-rate mortgages. You would save enough money for a down payment, and then you would go to a bank, credit union, or savings and loan. You'd schedule a meeting with a financial officer, and would say "Yo, Bailey, give me a loan," and George Bailey would look over your finances, and based on your past credit rating and the current interest rate, would tell you how much you could borrow and afford. Since it was a fixed-rate mortgage, you would pay the exact same amount every month. Thus there were no surprises as to what you owed. Since you had to pay a down payment, usually about 20% of how much you borrowed from George Bailey, your house was worth much more than what you owed the bank. In the early 1980s, interest rates were the highest they had ever been. Banks that had lent money at fixed-rate mortgages in the 1970s were losing money, since they assumed the interest rate would be much lower than it was at the time. Thus, they came up with the idea of an adjustable-rate mortgage. This allowed banks to lend money, and every few years the mortgage interest rate would change to whatever it was at the time. Thus, if rates went down, so would your payments. If rates went up, so would your payments. It was a perfect system with no downside whatsoever.

Now to the current debacle: In the early and mid 2000s, home prices kept increasing in a rate that was unsustainable. The Internet dot.com bubble had just burst, and interest rates were extremely low, as to promote growth. This caused mortgage rates to be cheap. People kept buying homes, which caused prices to rise even faster. Banks saw that home prices were going up fast, and decided to no longer requirement a down payment. Why require a down payment, when the home will be worth 20% more next year? To encourage more people to borrow money, they offered mortgages that would have a super low interest rate, which would reset in a few years to the market rate. Basically, banks started to behave like my Internet provider -- I get the first 6 months at 30 dollars a month, and then after that it jumps up to 55 dollars a month. People, mostly idiots, bought a home at the introductory rate. George Bailey didn't really care if people could only afford the introductory rate, because at the end of the teaser rate, they could always sell the house, and with how fast house prices appreciated, everyone would win. The bank would get their original loan back, plus the closing costs, and the homeowner would make a nice bit of profit. How could this ever go wrong? There are no variables in this equation, only pure profit. In fact, banks thought that this was such a super idea, and that there was no possible way this could ever fail, that they allowed people to invest in this business model. They would take money from other banks, foreign investors, and pension plans, and use this money to loan to even more homeowners. Here is the funny part though: they would tell these investors that their money was in one of the most secure investments possible, and even contractually guaranteed that their money was safe. Ouch.

Finally, something really crazy happened. It just came out of left field. No one could have ever predicted this in a million years. Home prices actually went down! Plus the Federal Reserve raised interest rates. People who bought homes had their monthly payments triple, and since they didn't need a down payment, they owed more money than their home was worth. Most people said "the hell with this," and let the bank take their home, which they couldn't sell. The bank was stuck with it, but since they guaranteed all that money to those investors, they were stuck paying for them. Banks didn't have any extra money, so they stopped lending to all people, no matter who they were. Their earnings disappeared, and their stocks started getting hammered. This caused the overall stock market to get killed. The rich people who belonged in hedge funds started getting scared, and started pulling their money out. Since this accounted for so much money, the entire stock market got murdered.