The Problem
So if this was such a good thing, how did it turn so ugly? Well the answer to this question centers on one very persistent aspect of investor behavior in that people tend to extrapolate current events too far into the future. In this particular instance, investors implicitly believed through their pricing of risks (or required credit spread over Treasuries) that the economic stability we enjoyed during the mid 2000s would persist. Premiums investors required for bearing the credit risks associated with MBSs, CDOs, ABSs etc., were not priced accordingly for the level of underlying risk.
