David Leonhardt with The New York Times wrote a piece this week on the topic:
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?”
He ends up with one of the clearest explanations I've seen yet. The problem wasn't simply risky loans turned into risky investments. It was risky loans turned into risky investments that were -- yes -- made even riskier:
Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody’s Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
... The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it.