First off, if there was falsifing of documents, whoever did it should be in jail and if it was condoned by the corporation, then fine them, through the CEO in jail, have a team of IRS audits set up camp for years to terrorize them! And so when the government (think community reinvestment act) says a bank must make subprime loans to low income people, or, you won't be able to merge or aquire another company, or expand in the market place, that had no bearing on banks making these loans. And let now forget Fannie and Freddie. They garanteed these loans. So, let's take the free market out by not having any risk to your loans. That won't change a corporations behavior. And when the banks fail, they should have. instead of spending $800B in bail out. They should have failed!
Some lower level people in some companies did go to jail but the fact is that the people who made the policies in those companies which mandated or rewarded the falsifying of documents typically were not since they were insulated from the wrongdoing.
Subprime does not mean that it will automatically fail. Subprime merely means it is not an "A paper" loan, that is a high FICO score. There can be many reasons for a low FICO score including a person relatively new to the credit market, a person who has had financial issues in the past due to illness, unemployment, among other reasons, excessive debt or lack of solid security. Everyone wants the "A paper" loans because they are safer but they also are lower profit makers. Subprime loans carry higher interest and fees and so have the potential for larger pay offs but with an attendant higher risk. The fact this exists is not the problem because when these loans are sold, if the purchaser knows what they are getting then they are taking on a risk they know about in exchange for the potential of a higher pay off down the road. The problem in the recent collapse was that subprime mortgages were packaged in creative ways which did not disclose to the buyers exactly what it was they were buying.
Subprime and regular mortgages which were traditionally isolated from, and sold in a separate market from prime loans were bundled together. These 'bundles' of mixed mortgages were sold as asset-backed securities so the 'probable' rate of return looked superb and the loans were secured against saleable real-estate, and so, theoretically 'could not fail'. Many of these mortgages had a low interest for the first year, and poorer buyers were able to refinance regularly at first, but as borrowers began to default in larger numbers. the inflated house-price bubble burst, property valuations plummeted and the real rate of return on investment could not be estimated, confidence in these instruments collapsed, and all were considered to be almost worthless assets, regardless of their actual composition or performance.
So as I said there are a number of problems which existed.
1. People who should not have received loans did via lenders using "creative" accounting methods to make income and assets appear to qualify. Misrepresentations were made to borrowers as to their ability to qualify as well as to refinance later. People who are less than sophisticated in financial affairs of this type relied on those representations.
Stop and think for a moment. How many have ever bought real property? Remember the paperwork you had to sign? The stack is immense, many inches high. How many of you read every word on every page and understood it? How many of you relied on what your real estate agent or attorney told you about what the documents said?
2. Lenders and at least some purchasers willingly engaged in a delusional scenario in which property values would only increase and never decrease which anyone with any experience in financial markets, knows is patently false.
3. Politicians on both sides of the aisle cooperated by removing or reducing financial market regulation and oversight on these markets allowing people to do as they wished without having to worry about getting caught.
4. Huge amounts of money were being made, on paper at least, and this fact was regularly pushed by the media and companies selling the bundled loans, which encouraged investors to buy paper which the sellers knew was worthless or close to worthless.
