Given the fact that institutions giving out the loan did not take the risk, their incentive was in just giving out the loan. Whether the individual taking the home loan had the capacity to repay the loan or not, wasn't their problem.
Thus proper due diligence to give out the home loan was not done and loans were extended to individuals who are more likely to default.
Other than this, greater the amount of loan that the institution gave out, greater was the amount it could securitise and, hence, greater the amount of money it could earn.
After borrowers started defaulting, it came to light that institutions giving out loans in the sub-prime market had been inflating the incomes of borrowers, so that they could give out greater amount of home loans.
By giving out greater amounts of home loan, they were able to securitise more, issue more financial securities and earn more money. Quite a vicious cycle, eh?
Image: A foreclosure sign sits in front of a home for sale in Stockton, California. | Photograph: Justin Sullivan/Getty Images
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