Mind you, catering to only 'high-risk' borrowers is the definition of madness. I just can't see why any lender would do that: the odds of writing off loans would be several orders of magnitude greater than a more conservative lender. And they were intending to do what with all these default loans?

Higher risk means higher interest rates and more potential to make money. The trick in the past was picking through the applicants to find the ones that would pay back the loans. But that limited the market size and some creative accountant invented a better solution.

The method used by lenders now is called securitization. Groups of loans are converted into securities that can be bought and sold. The seller gets cash now and the buyer gets the future interest income. That way the lender doesn't have to hold all the risk of default, and gets more money they can loan out. For the buyers, they are buying a lot of money over the term of the loan at a pretty big discount now.

That is the theory, the reality is much more complex and involves some pretty shady dealing. Apparently in most cases the companies buying these securities have deals which require the lender to buy them back if the default rate rises too high. This means of course that the lender has not really removed the risk. But since the lender's profits and stock price where based on the number of loans they could sell they had every motivation to push as many loans as they could.

The end phase was essentially a Ponzi scheme for some of these lenders. They had to move more and more loans to get enough money to keep ahead of the buy back on bad loans. But that forced them to make increasingly bad loans to get the number of loans up. And eventually they couldn't keep ahead of the cycle.

Jay