A Brief Discussion about the reasons the subprime machine was doomed from the very start...

Subprime Lending worked as only long as interest rates stayed low and housing prices continued to rise.  Trouble is, we live in a dynamic economy. 

Rise... 

In a dynamic economy, stock values rise and fall, inflation rises and falls, interest rates rise and fall, the housing market is famously cyclical.  Therefore, the odds of interest rates remaining low and housing prices rising together - the very conditions under which subprime mortgages and securities backed by them could work - for more than a few years are really very long.  If you think Wall Street and its army of lenders didn't grasp this very basic idea, think again.  Still, subprime worked very well for Wall Street for the first few years.  Asset Managers like Cioffi were the toast of the Street.  But there was no way it could last.

When interest rates eventually rose - they weren't going to stay at historic lows forever - adjustable rate mortgages adjusted right on up with them.  This was a foreseeable and titanic problem for those who could just barely afford their mortgage payments at the original payment level. The potential saving grace was the home equity that homeowners enjoyed as a result of the skyrocketing house prices of the housing boom.  Of course, many subprime borrowers - often encouraged or cajoled by subprime lenders - had already borrowed against this equity to do things like put in swimming pools, remodel the master bath, and make a wide variety of home improvements. These folks didn't have very much equity, if any, to draw upon when interest rates started to spike.  

And Fall... 

As interest rates kept rising, the pace of the booming housing market began to slow.  Then home prices flattened out.  Defaults of subprime mortgages were rampant.  Then, in many parts of the country, home prices even began to dip.  Goodbye equity.  Hello more and more subprime defaults.  Foreclosures reached into the millions.  Subprime-backed securities no longer had mortgages worth anything to stand behind them.  Suddenly, there was no market for Mortgage-backed securities, especially those built on the backs of subprime mortgages.  Securities with no market are illiquid.  Illiquid securites are worthless. The subprime game was over.

The death of subprime wasn't just predictable, it was a sure thing. You just can't build an industry on the hope that people with bad credit will adopt new habits and begin to reliably pay their bills.

Illustration No. 1

Credit Default Swaps; reprinted from the New York Times online

ILLUSTRATION No. 2 - CDO Meltdown