It goes back over a decade to Bill Clinton. In between sessions of polishing his presidential knob, he had a great idea - give home loans to the minorities and poor so they can also live the American dream. George W tried to fix it a couple of years back but he was so far on the nose that even his own party thwarted his efforts (apparently).
So the lowdoc/nodoc loan proliferated. Unfortunately most of these people did not have loans previously for a reason (they had no hope of paying them back). The logic was that the cost of land would continue to increase and thus after a very short time, the banks would be covered for those loans that defaulted.
Many of these banks then on-sold the debt to other banks (mixed with a spattering of not so toxic debt) very much down playing any risk (afterall the cost of land never goes down does it?). Further more, some smart investors realized what was going on and started short selling the banks who were buying these "assets". More about this in a min.
Now, come mid 2007 and the American economy starts slowing and the housing market becomes depressed. All of a sudden many homes that should have been gaining in value were actually going backwards. Because of the slowing economy many were loosing their jobs and couldn't pay the mortgage. Further, many found their homes were now worth way less than they owed. Most American mortgages have a curious clause in the fine print that says that if the consumer can't pay the mortgage, they can simply return the house to the bank and be absolved of their debt (it becomes the banks problem to sell it and recover their money). The UK had a similar system till they had the same problem in the early 90's and changed to a system more similar to Aus where the bank can auction your house but if they don't recover all the money owed, the consumer is still liable for the balance.
Anyhoo - The term "Jingle Mail" comes from americans posting in the keys to their houses to absolve them of the debt. A few thousand at a time would have been a problem but nothing dramatic. A few hundred thousand was a major disaster. All of a sudden the banks had thousands upon thousands of assets with a book value of (say) $100,000 each but in reality were worthless. American banks went from a situation where there was a mild oversupply of houses to a huge oversupply as the keys rolled in. Property values collapsed.
Now, back to the "smart" investors who picked what was going to happen. These guys were shorting the banks such as Lehmen Brothers and Meryl Lynch (and many others), in effect betting that these loans were going to go bad. Then, when they did, for a relatively small investment (say $10,000) they profited several hundred thousand, thus multipying the effect of any and all bad loans to a level the world has never seen before.
Next, all these bad loans had been bought by banks all over the world (much like insurance underwriters do with insurance contracts) and put simply banks didn't know who they can trust any more. The entire wholesale money market shut up shop overnight. Put simply, banks didn't trust each other and they did (what every body else did) and pull their money out of international equities etc and held as much cash as possible, thus the wholesale drop in share markets around the world.
All of these factors have a snowball effect, what starts out as a small or moderate problem gets bigger and bigger as panic sets in. Now the world has a mess to clean up.
Reaper
