Crime and Crisis, Bursting Bubble

What causes a bubble to eventually burst? What causes people who buy because others are buying to all of a sudden stop following the herd? It’s difficult to say. It is particularly difficult to say with financial assets such as stocks (or with sublimated physical assets such as tulip bulbs): a thing only has the value that other people give it might reach any conceivable value.
But houses are not like that. People must live in a space, and that space typically is a house or some other similar habitation. One might be ecstatic at the booming price of one’s stock, but not at the rising property tax bill. One might choose not to buy a single share of stock in the midst of a mad rush. People with families often may not be able to choose to abstain from buying a house during a housing frenzy. So it was particularly obvious (ha!! It’s so obvious in hindsight, but so many of us told incredible lies to ourselves) that house prices must reach a plateau.
When housing prices reached a plateau, the Ponzi scheme could not longer be maintained. The game of buying a house that is too expensive could only be kept up with continued rapid housing appreciation. Lenders would only lend a extremely high loan-to-values if they were convinced there could be no losses. Borrowers could only refinance and avoid default if the value of the collateral continued to grow.
Mortgage defaults on the most egregious of loans began to occur, and projections of lightning-quick sales fell flat in the absence of the extremely easy finance on which they depended. The securities based on these mortgages became worthless and so did the shares of the companies holding them. Financial institutions that had gambled on the real estate market - directly or more often, indirectly through derivatives - began to get pinched. Finance dried up. So did sales. And prices did the unthinkable and began to drop.
The basic promise of a financial contract - to yield an uncertain return through an uncertain mechanism at an uncertain date, but to yield a future return nonetheless - could simply not be believed any more. Liquidity disappeared, first for the institutions that were most obviously connected to the mortgage market, but then to firms that would have been solvent except for mark-to-market requirements (in general a good idea, but not so when the market effectively disappears, taking along with any sense of patience).
The sense of proportion was lost, the sense of what excessive risk taking or leverage might look like, and whether we should avoid them. A sense in the credibility of a financial promise was lost, not only because the value of the securities could only be expressed in terms of an equation that was not robust to crises, but also because of the immensely bloated incomes of the financial sector at a time when their clientele was increasingly strapped). And, having lost the belief in the company’s solvency, liquidity for continued short-term operations was lost.

So it was the homeowner and the mortgage broker, Main Street and Wall Street ... and also K-Street and Constitution Avenue and Lombard Street and Madison Avenue. Todos a una, Fuenteovejuna.