The credit crisis reflects the collapse of a tower of structured finance products
based on subprime mortgage loans. These instruments—RMBSs, CDOs, SIVs, and
CDSs—shifted the risk of mortgage lending, especially the default risk,
from one party to another, until many lost sight of the real risks of the
underlying loans. But when housing-price appreciation reversed, many subprime
borrowers, having made only negligible down payments, owed more on their
mortgages than their houses were worth. These borrowers exercised the put
options in their mortgages, and defaults rose beyond the expectations priced
into mortgage rates, RMBS yields, and CDS premiums. The downside risk of
housing-market prices was shifted to lenders, and losses, magnified by vast
leverage, spread up the tower of structured instruments to CDO investors and CDS
sellers. The real risk of subprime mortgage investing became apparent, blowing
up financial firms and, in turn, the economy.