Reply #8: Not the homeowner's faults..true..

[Lucky Luciano]

It is definitely the fault of the lenders lending irresponsibly to people who clearly could not pay back the loans. Lending to people that don't have money is, in a word, retarded. The trouble was the shortsightedness of the business that saw others making money originating any loan they could get their hands on, securitizing a bunch of them, and sending them off to the general market for investors to buy. The trouble is that with interest rates so low, investors needed to make riskier loans to get higher returns - gotta get the juice! Same thing in corporate credit with people investing in "covenant-lite" investment grade bonds (to get higher interest rates)...only to have an LBO occur, fucking them over in the capital structure with other creditors lining up in front of them in an entity levered to the gills. Credit markets had spreads that were just way too tight and everybody was along for the carry since shorting credit was so damn hard....that is, until they got carried out!

Banks and I-Banks invested heavily in mortgages through CDOs (That package mortgages together in different classes (or tranches)). In order to get the juice that investors wanted, they would invest in the traunch that suited them - the banks would often sell out the "risker" tranches and just hold the AAA rated tranches thinking they were virtually risk free...trouble was that they were not. An individual loan in the AAA tranche would have been viewed as almost default free at the time of issuance...but this is a big group of similar loans....so if some of them start defaulting and the correlation is big (and grossly underestimated), then many of them start defaulting....these AAA tranches that should not have any default risk are selling for pennies on the dollar - and the banks are levered up on these babies, so a 20% default rate in the CDO absolutely CRUSHES them...and you get these enormous writedowns like Merrill's $9B writedown and all the other monsters coming our way.

Ratings agencies (S&P, Moody's, Fitch) badly miscalculated the ratings of the AAA tranches...they clearly had no understanding of the evils of high correlation when things go to shit.

I have been rambling....for sure...That said, one part of your post, I do disagree with:

"For each dollar of foreclosed mortgage debt, there are many dollars of other debt leveraged on top of it by banking and investment firms."

You insinuate that banks should not be levered. Then they are out of business. The very nature of the business requires leverage - and lots of it. Which is why a good risk management system must be in place. That was what was lacking (unless your bank was Goldman Sachs - who outmaneuvered, and made a huge killing by shorting the subprime loans).