The pieces for a classic financial drama fall into place one by one. First, the U.S. financial system, by way of a huge current account deficit and lax fiscal and monetary policies, gets flooded with resources for lending. Next, in their quest for attractive returns, banks and other intermediaries find subprime borrowers eager to buy houses they previously couldn't afford. House prices start going up, and soon a boom, fueled by cheap credit, unfolds. As financial intermediaries continue to be chock-full of liquidity they become too "creative," finding ways not only to spread and hedge repayment risk but also to overlook it. Everybody is happy. More and more subprime borrowers buy property, while others take on new debt on what they perceive to be their enlarged home equity. Intermediaries who got into the game early gorge on profits, and once others become aware of it, herds of them stampede to graze in the same pastures.rnInitial enthusiasm for new opportunities turns into euphoria, and sound assessment of risk becomes even less relevant. In fact, in the face of rising prices despite the huge supply of new homes, additional debt is contracted to leverage the acquisition of more mortgage-related assets. Home financing becomes speculative, since debts can be paid off only if the underlying assets can be sold at an appreciated price. It's now not only about mortgages but also about a vast array of arcane financial products stemming from them in multiples. Once again the markets forget that financial innovations are likely to be underpriced and therefore overdemanded. At this point we find ourselves smack-dab in the middle of a housing bubble.
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