My understanding of these things is that this kind of debt is mostly unsecured. If a house is repossessed and sold at a loss after the mortgage has fallen into arrears by more than a certain percentage, the unsecured creditors get nothing. Of course, now nearly every repo is sold at a loss, and there are 2x as many empty properties sitting on the books as are advertised for sale, so that's not going to change for a while.

Remember that the toxic asset is not a collection of salami slices from different mortgages - there are laws against dividing up a mortgage or loan interest that way, I believe. The slices were claims on the profit - the sum of mortgage payments minus cost of capital, and were paid out in exchange for cash up front.

Holding these assets seemed like a good idea at the time they were issued, because even if Joe Blow lost his job or whatever, the rising property market meant that he or the loan service company just had to be patient for a few months - then the house could be sold for more than the value of the debt, the unsecured creditors would be OK. Joe Blow himself would have a clean slate unless he was truly incompetent, because before the bubble burst it was fairly easy to offload the property and look like a responsible individual who serviced debt promptly. I heard of people doing that and ending up with a better credit rating as a result, because on paper they were now the sort of person that does profitable 6-figure real estate transactions. The smart ones gave classes, the stupid ones believed their credit reports and started thinking they were financial wizards.

On the issue side, it worked like so: I give Joe Blow a $500k mortgage, he is supposed to give me back $1m over 20 years or whatever the compound interest + principal amounts to. Well great, but now I have to wait a decade before I start actually making money on the deal. Traditionally, banks' business model is to control enough capital and manage risk well enough to play that long game, in fact to play a longer game than anybody else on the market. But in recent decades, so much money had gone into the stock market via retirement funds etc. that bringing in your profit over a 10-30 year period looked rather tame. Sure, there were big profit multiples in the credit card business, but it takes time for most people to run up substantial credit card debt, and the kind of people who rack up house-size debts quickly are unfortunately the sort of people who tend to pay them off too because they understand how to use credit effectively, so they are not generating any profit. And in a rising market, those long-term profits seem to have a very high opportunity cost, because although they are secured by property, I could probably double my money faster by investing it in some dot com thing, whatever that means...

Meanwhile, I'm out the $500k I just gave to Joe Blow, and my competition across the street is just celebrating an IPO of clueless,com that paid off at 32:1. Damn! But wait - YOU look like a smart guy. Look, I have this mortgage on Joe Blow's house, and 99 others just like it. Houses - lovely solid assets, not like those inflationary stocks. They're even better than gold, because you can't live in a goldbrick, amirite? And who invests in gold, that's no way to make money any more, the 70s were a long time ago.

I'm gonna collect $500k from Joe over the next 20 years! He'll pay because it's his house, duh. My cost of capital from the federal reserve? Cheap, they only want $100k in interest, God bless Alan Greenspan. No, you can't raise capital there, you need a banking license like I have but they're like taxi medallions, you gotta wait years to get one. But look, about this $400k profit I make after I pay the Fed off. Times 100 mortgages that I've issued, that's $40 million dollars of pure profit - and this profit is on debt secured with $50 million worth of houses...at today's prices. And they're not making any new land, heh heh!

Oh, you wish you could get in on this? Yeah, too bad you don't have a banking license like me...but come to think of it, don't a lot of taxi guys rent out their cab, and everybody wins? Yeah! How about this: you give me $50 million, and I'll split the $40m profit with you, even Stevens, $20 mil each and I'll do all the hard work of collecting the payments each month and I'll hold all the risk. What's in it for me? Well, I'll issue some more mortgages, I got people trying to buy property faster than the hired help can build it. What's in it for you? $20 million my friend, and peace of mind. How long do you think this bank has been here?

OK, it was more complicated than that - there was an investment bank in the middle giving the sales pitch and gift-wrapping the item, and they were getting paid a commission up front. But this was the basic transaction that both sides suckered themselves into, and on which both sides lost money while the investment bank kept its cash commission.