Remember when real estate was considered a good investment because the prices were going up and up and up some more? A lot of that was people buying houses because they were such a good investment. And people would buy houses that they couldn’t really afford, thinking that they’d just “flip” them soon and make a profit, because the price would go up. And these people, among others, would get mortgages that were too big, because it was such a good investment.
Well, the price of something can go higher than what the thing is really worth. And if a bunch of people think that the market is inflated, they no longer agree that the thing (houses, in this case) are worth that much. If you can’t get someone to buy the house, the price doesn’t go up, and that’s when the bubble “burst.”
Remember all those people getting mortgages to buy those houses? A lot of them were poor credit risks. They listened to those TV commercials that promised mortgages “for bad credit, no credit, no money down, we’ll put anyone in a house.” And everyone was very surprised when people defaulted on these mortgages. Then the bank comes in and takes the house, for people all over the country that default. Suddenly there are too many houses in foreclosure, and the bad debts that are probably never going to be repaid echo throughout the economy.
Then, with so many foreclosed houses sitting there, they cause the value of the other houses to go down. One reason is because there’s no one taking care of it anymore, and it becomes a blight in the neighborhood. Also, foreclosed houses sell for much cheaper, driving down the prices of other houses trying to compete in a buyer’s market. And when the value of all the houses everywhere go down, suddenly a lot of people owe more on their mortgage than the house is “worth.” Some walk away and let it be foreclosed at that point, beginning the cycle again, like a big row of dominoes falling over.
That’s pretty much the story in a nutshell. And when you realize that all those bad mortgages were sold as “good investments” to banks, retirement plans, and general investors (who now had their money sucked down a valueless black hole), that’s why the rest of the economy is collapsing, too.