Most traditional mortgages are fixed-rate. Homeowners agree to pay the bank __% over the course of the mortgage in return for the bank providing payment up front. The house is collateral so the bank doesn't lose money if the homeowner fails to make payment. Variable rate mortgages are simply promises to pay the bank a certain percentage over its own cost of securing funding. This is usually tied to inter-bank lending rates.

Variable rate loans were popular with banks because they pushed risk onto homeowners. Banks no longer risked losing money if their cost of borrowing spiked (and interest rates were at historic lows....). The same loans were popular with speculators who could get cheap capital to purchase housing in a rising market.

This causes: (1) an explosion of variable rate mortgage products, and lots of people getting them to cover real estate purchases, (2) increased (speculative) demand which drives up housing prices and encourages speculation, (3) people going further into debt using the increased value of their existing property as collateral. In many cases homeowners took out second mortgages just to give themselves more free income. This is a lot like borrowing cash from the bank using your Pets.com stock as collateral back in 1999.

The game becomes untenable in two situations (1) when money stops flowing into the housing market and prices stop rising, or (2) when interest rates rise.

The Republicans have really screwed up here. The Fed is trying to lower the cost of borrowing between banks to help push down the interest rate and keep people from being forced out of their homes by rising payments - a situation that would only exacerbate the financial crisis from the perspective of lenders who have paid $$$$ and are now stuck with the collateral worth $$ and falling. Banks are failing and so banks don't want to lend money to other banks. This causes the inter-bank borrowing rate to shoot up, further exacerbating the problem.

Now that spreads are soaring again we can expect a lot more foreclosures which will push more glut onto housing markets and tank the price of property. Perhaps even the collapse of the banking system. That might have happened anyway though, since no-one has any clue about what sort of money is being lost in derivatives.

Act I: "Alan Greenspan: 'The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.'...

What he’s technically saying is he’s going to keep the Fed Funds rate at the absurdly low level of one percent. It tells every investor in the world: you are not going to make any money at all on US treasury bonds for a very long time. Go somewhere else. We can’t help you."

Act II "And they sold so many mortgages that there came a point in 2003 where just about everybody who wanted a mortgage and was qualified to get one .... had gotten one.

But the pool of money had just gotten started. They wanted more mortgage backed securities.

So Wall Street had to find more people to take out mortgages. Which meant lending to people who never would’ve qualified before."

"At the height I was making between 75 and 100 grand a month" -Glen Pizzolorusso, who was an area sales manager at an outfit called WMC mortgage in upstate New York."

Act III: "The global pool of money is avoiding anything with even the slightest hint of risk and that affects everybody, no matter who you are. It's harder to borrow money to buy a house, or build a factory, or bring your country boldly into the 21st century. Take Iceland. A year ago it was easy for them to borrow billions. Now, they're seen as too risky. Their central bank has to pay more than 15 percent interest get anyone to loan them money. They could do better putting their national debt on a credit card."

With the economy tanking and the money tightening if they raised the interest rates, nobody would borrow and the situation would get even worse.

Also, the above fundamental philosophical differences are one reason why this stuff just shouldn't be here: people completely disagree and are just going to go on and on and on without really concluding anything.