There were a confluence of factors and no shortage of actors, each with their own incentives, but, I will focus on a couple here as possible spark plugs for what we just saw happened.
Number 1
A belief by all actors in the system that home prices simply went up (and thus, that there would always be alternatives to a foreclosure - selling the home or refinancing).
This led to the creation of products that expanded the buck and focused on simply the initial payments to qualify a borrower. "Tomorrow is always better than today" - and the adjustment periods became shorter.
Also, additional risk layers (that permitted the borrower to take more risk- not necessarily tied to an adjusting payment- but to borrow more relative to the value of the home or borrow more from their own income to pay for the mortgage) were permitted for a low price (again, the belief that the risk of default was very low).
Investment Banks (nothing new)
The investment banks saw an opportunity to deliver paper to hungry investors (for yield) and simply looked for ways to deliver that yield - ever more risky assets ended up in paper that was sold to the market. It was then not the assets themselves but their structuring that let to the higher yield. Perhaps investors were not willing to take on higher yield in a risky asset by itself, but, if it was packaged in a particular way, then they were able to take it.
These two were not only spark plugs, but, they were necessary conditions for the feeding frenzy to continue (with one additional item - the appreciation of homes - for the party to continue homes actually had to appreciate in value).
While there were spark plugs and necessary conditions. There were other things that permitted to fire to expand so fast. Like the wind is to a fire, there was the channel itself - Wall Street needed paper with a higher yield to put into securities (because they were able to convince investors, for whatever reason, that it was good), well, "we know how to find mortgages" and by the way if you didn't like the yield I found you the last time (high LTV, high DTI), here is how we can find more yield (stated income, lower FICO)... So, what is the channel? it is composed of mortgage bankers, mortgage brokers, realtors (who were able to sell more homes), appraisers (who were able to make more appraisers), and others...
So, it was a great, great world - borrowers were able to get better and bigger homes, brokers and mortgage bankers made fortures, realtors sold homes like never before, appraisers had more business than ever (and btw, to remain competitive they needed to become more lax in their stds, because otherwise, the bank - who pays them would simply go next door - this is a different topic, how do you uphold your stds in feeding frenzies and still manage to do business, it is almost like losing in every direction, but, this point applies to everybody - brokers, bankers, appraisers, wall street and even investors), wall street was getting some fat fees, and investors were getting great yield.
Which gets me to the following point (which is already implied up there)... whenever
(1) a deep belief (that is contingent on certain (up to that point) illogical elements happening) is ingrained in a market (can be led by some of the players),
(2) that is linked to a (significant) profit opportunity among many dispersed players, and
(3) not everybody has the same information, and
(4) those with the most information are compensated based on commissions (not taking any risk or if they can control the risk - for example, mtg bankers taking equity out of their companies every year)
other necessary elements:
- hot potato based on risk - people believe that if you ever run into trouble, you can simply unload by selling
- belief that the private markets always come up with the optimal outcome and that they regulate themselves (i.e. excessive risk taking would come by the way of losses)...
- transaction based income for main players - no skin in the creation of the hot potato...
the results?
Investors: made yield for many years, hot potato was dispersed (although some took real risk)
Investment Banks: made money, transactions, profits during those years? hot potato write-off (the little of what remained)
Brokers: made money, transactions, no skin
Bankers: made money, transactions, pulled a lot of money out
Realtors: made money, transactions, no skin
Appraisers: made money, transaction, could lose their license.
Mortgage holders: they are the ones that are holding the two key assets: the homes (that can drop in value) and the mortgage (that they can potentially not be able to pay) - some however, got a mortgage that they would not have gotten otherwise and will still be ok...
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