Eventually, the mortgage lenders caved. With housing affordability collapsing, there was no longer a way to squeeze marginal home buyers into mortgages—at least, not without some disingenuous slight of hand. Not only was it tough to make a new loan, but a growing number of recent borrowers, mostly flippers, weren’t even making their first few mortgage payments. Even though the lenders didn’t own the loans (they had already been sold for securitization), the terms of those deals left lenders on the hook for any losses that occurred soon after the sale. This was a modest attempt to dissuade fraud. Now these early-payment defaults became a call to arms for nervous regulators, who finally took action and issued new rules to limit some of the more aggressive types of lending.
As their losses began to mount, some mortgage lenders sold out and found buyers for their businesses in still-confident investment banks. The Wall Street firms calculated that the loan originators’ losses would be short term and that they themselves would be well compensated in the long run through the extra securitization business their ownership would bring in. But by the end of 2006, even the investment banks began to lose heart, and loss-plagued loan companies found nobody wanted to buy them. The only recourse for many lenders was bankruptcy and, ultimately, liquidation.