Well, I was trying to wade through the crap to understand what caused this shit ?. And I tried to talk to people whom I think knew the answer. Honestly, I never got a convincing one let alone one that doesn’t sling another question. However, I realized that I am getting somewhere. So, let me try to explain what i understood.
Long ago, banks operated on a simple algorithm. They collected deposits from people, paid them a little interest and lend a part of that money to people who need them and taxed them an interest. Money in the bank was always greater than money that was lend out. The deposits/investments in the banks were the assets. Government bodies made sure that assets are always greater than liabilities. The process to borrow money was more stringent. Only people with excellent credit history were allowed to borrow.
That theory worked really well for ages. But if you look closer, there is a fundamental flaw in the above model. What that brings in profit should be your asset. Right ?. So its the money that is borrowed from the bank is bringing in the profit, not the one sitting in the shelf. Suddenly banks started operating on the basis of this new revelation. More money you lend out will bring in more profit. Your liabilities suddenly became your assets.
Starting the beginning of this century banks allowed people to borrow money more and more. They introduced offers and sales promotions to attract new borrowers. People who never even been able to acquire a loan few years before all got shit load of money. Banks never bothered to calculate the risk in lending money out to a borrower. Instead they taxed them with high rate interests. So more the money lend out more the assets. Banks and financial institutions are happy, borrowers are happy; every one is happy. People borrowed their money and invested in their houses. So the housing market boomed. A shack would cost millions and appreciated in months. More and more people took the risk to borrow money to invest in bigger houses they couldn’t afford in the first place. Banks never bothered, because they are happy to show all these as assets in their year end balance sheet.
Things became bit wacky when banks realized the borrowers are defaulting on the payments. People started abandoning their homes to move to apartments. Those abandoned houses went foreclosure. There were none even to buy the foreclosure homes. Hence the fundamental structure behind the whole theory started to shake. Banks went bankrupt. The rest is what you are seeing these days.