1) People (greedy ones) with bad credit are allowed to leverage themselves 30:1 to buy houses they can’t afford. This is OK as long as house prices keep going up: Can’t make a mortgage payment? Refinance! Too bad nothing goes up forever.
2) Aggressive (greedy) banks leverage themselves 30:1 and invest in the mortgages of the (greedy) people who leveraged themselves 30:1 to buy houses they couldn’t afford.
3) House prices keep going up because everybody is borrowing like crazy to buy houses. Everybody borrows like crazy to buy houses, because house prices keep going up…. Welcome to the bubble.
So you get bets on a speculative bubble leveraged at 900:1, and companies like AIG selling insurance and default swaps on those bets. When prices go up, the profits in the system are multiplied 900 times, and when prices go down, the losses are multiplied 900 times. Too bad nothing goes up forever.
The government bails out the biggest corporations in the nation (they are “too big to fail”), the politicians talk tough, and some stuff is banned (maybe, credit default swaps). Then, a few decades later, it all happens again, because you can’t ban greed.