With lots of cash on hand, banks lend to anyone and everyone to buy a house, including those with poor credit history (i.e. “subprime” mortgages). After signing on the dotted line, many homeowners (who are enjoying soaring housing prices) take out lines of credit on their new home equity.

Banks are selling the mortgages they make and pooling them into financial products (“securities”), many of which the rating agencies say are safe (rating the securities AAA, when really they’re mostly junk!). Banks then sell the products to one other (mortgage-backed securities) en masse, and even buy and sell insurance for these products (“credit default swaps”). In other words, a ton of betting that’s all based on mortgages–many of which have been given to people who really can’t pay them.