In the old days, if you wanted to buy a house, you went to a bank. The bank would assess your ability to repay the loan and collect a down payment to ensure that you had some "skin in the game." The bank typically held the loan, providing an incentive to ensure that a borrower wouldn't default.
In short, all the players had a stake in the success of the borrower repaying the loan.
That system, however, was thrown out the door in favor of a new system where no one had a stake in the success of a mortgage loan.
Lenders marketed loans that required little or no down payment and little or no documentation of income and assets. Middleman brokers who steered borrowers to these higher-cost loans would get fees, regardless of the borrower's ability to repay.
And lenders shifted from the old "book-and-hold" model (in which the original lender continued to hold the mortgage) to an "originate-to-distribute" model, in which the lender held mortgages briefly and then sold them to Wall Street firms, which in turn packaged them to sell to investors.
As a McClatchy investigation in Sunday's Bee shows, this house of cards was hugely dependent on credit rating agencies (Moody's, Standard & Poor's, and Fitch), which gave the highest triple-A investment grade ratings to these pools of risky home loans.
To read the complete editorial, visit The Sacramento Bee.