As the AIG bailout news hit the wires, I kept hearing vague references to subprime mortgages and the housing market, and my interest was piqued.  I set out to find out how the problems of AIG, an insurance company, impacted the housing market.  Fortunately, I came across a great article by Chris Isidore at www.cnnmoney.com which provided an excellent explanation of how the two are tied together.

"The reason housing is wreaking havoc even on insurers like AIG and big investment banks, who do not make mortgage loans, is that during the boom, trillions of dollars of mortgages were packaged together into securities that promised to pay investors with the proceeds of those loan payments.  Those securities paid better rates than other types of assets during the boom years.  So many investors from around the globe poured as much money as they could into those securities."

The increased demand for these securities, caused lenders make more loans, some of which were made to borrowers who had flawed credit or not enough income to sustain the mortgage. 

When the housing market was hot and prices continued to tick upwards, the steady demand insured that a homeowner would able to sell his/her home fairly easily.  The problems only began to surface as the housing values began to fall and more and more properties went into foreclosure. 

The rise in foreclosures, in turn, caused the value of some securities tied to mortgages to drop.  This decrease in value resulted in massive losses up and down Wall Street.    As these losses filtered into the fabric of our financial markets, confidence eroded, with the final result being lenders who are very reluctant to extend credit because of the increased risk.