The banks from whom investment banks such as Lehman Brothers had purchased mortgage loans could send monthly cheques that they obtained from the creditors of mortgage loans. When an investor bought CDOs, he was supposed to get a share of the monthly EMI paid by of the real borrowers of the mortgage loans. This was precisely what Lehman Brothers along with other investment bankers used to do.
They disperse the EMI obtained from the loan issuing banks one of the investors in the funds like SIVs. As demand for the CDOs began growing across the global investments community, the investment bankers that were meant to sell these tools also began investing a substantial part of their own capital in these capital.
Gradually the markets for CDOs started enlarging with investors and traders selling and purchasing these as though they were shares of a business.
They forgot the security of these loan based goods depended upon the repayment ability of the creditors that took the loans. As investment banks such as Lehman were churning more mortgage loans to CDOs and selling them investing their own money, there was a strain on the banks to issue greater loans that they may be sold into the Wall Street companies for a commission. Flowing with the flow of requirement for greater loans, gradually banks began decreasing the credit quality and vigorously employed brokers to source new loans.
It had been sometime in 2005 that this slippery slope went into such an extent that nearly anyone in the United States could purchase a house worth $100, 000 or greater without income proof, without other assets, without credit history, sometimes even without a regular income source. These loans were termed as NINA .mortgage loans were easy to get, so a lot more individuals were buying houses. And as of the eternal Law of Demand indicates, the increased demand for homes caused the price to increase. The rising prices created even more need, as people started to look at houses as investment – which never went down in value.
Herding behavior was working over there and individuals in the real estate sector was on cloud 9 then. In late 2006, Mortgage lenders smelled something wrong that they’d never seen before. People would choose a home, sign all the mortgage papers, and after that fail to make even their first payment. This phenomenon was attributed to of the rising rate of interest from 2004-2006. The majority of the creditors had taken loans on variable rates that began getting reset to higher rates, that in turn meant higher EMI that borrowers had to pay. However it was unexpected and unplanned for of the borrowers.