Because of the rising prices, the consequences from all the bad loans given to people who could not afford them were delayed. Whenever people experienced difficulties making their mortgage payments, they could easily take another loan against the value of their house, simply because now it was worth more.
Once people started defaulting on loans in record numbers and once the word got around that things were bad, the mortgage crisis really heated up. Banks and investors began losing money.
Financial institutions decided to reduce their exposure to risk very quickly, and banks hesitated to lend to each other because they didn't know if they'd ever get paid back. Actual bank weaknesses prompted additional bank failures. The FDIC ramped up staff in preparation for hundreds of bank failures caused by the mortgage crisis, and major players of the banking world went under.
The general public saw these untouchable institutions collapse and panic increased. The International Monetary Fund estimates that financial institutions around the globe will eventually have to write off $1.5 trillion of their holdings of subprime mortgage backed securities. These losses have wiped out much of the capital of the world banking system.
Future of the economy
A massive reduction in bank capital has reduced the credit available to businesses and households. Just how far-reaching the impact of the subprime mortgage crisis will be, both in the United States and around the world, no one can say with certainty. The best situation for all parties involved remains one in which the United States economy does well and real estate prices reach a permanent bottom.
Regulatory oversight with the investment banks and credit rating agencies is bound to create more decisive and strict regulation after this fiasco. Lending restrictions and bond ratings could stay very conservative for the next few years. Nevertheless, after every crisis a recovery comes and there is no doubt that future holds another speculative bubble in hand. As we learned from the history, irrational exuberance is always lurking somewhere nearby.