They ignored their own self-interest in not buying more homes they could afford out of ignorance, and the bank did nothing to deter them because the bank was cushioned from risk in the world of credit default swaps.
Credit default swaps transfer the risk of lending money to other economic entities. Credit default swaps are the main reason for the failure of the insurance behemoth AIG that was otherwise financially sound, except for its purchase of the risks of too many bad 'NINJA' loans. In these swaps, "the insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small," giving banks an incentive to extend bad loans and then sell the risk ("Credit default swaps," Times Topics, 2008). Then, when the "mortgage-backed securities that many swaps were supporting began to lose value in 2007, investors began to fear that the swaps, originally meant as a hedge against risk, could suddenly become huge liabilities" and tried to sell them on the open market, which of course no for-profit organization wanted ("Credit default swaps," Times Topics, 2008). Buying up bad loans, which may or may not be repaid at some point, was one of the cornerstones of the proposed economic bailout -- only the federal government will buy up the loans which are worth, most economists believe, next to nothing given the likelihood they cannot be repaid.
The new financial innovations like credit default swaps essentially neutered the moral hazard that is supposed to be a built-in check into...
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