At the end of Crisis and Regulation Part One I said that mortgage lenders packaged mortgages they had made together into mortgage-backed securities, and then sold them to "someone else." This meant that because they quickly unloaded the mortgages, mortgage standards declined, which many loans given to the NINJAS. The "someone" who bought these mortgage securities were the investment banks- think Goldman Sachs, Bear Sterns, Lehman Brothers, Morgan Stanley ect.
Now a word about invesment banks: the process of investment banking is essentially the inverse of the process of commerical banking. Investment banks purchase securities from issuers and then sell them to the final investors. For example, investment banks are how firms sell stock when they wish to issue more: Goldman Sachs will purchase x number of shares from Apple and then sell those shares to the general public; the margin between the purchase price from the issuer and the price they get from the public is their profit. So investment banks act as an intermediary between those selling assets and those wishing to buy them, as opposed to commerical banks that act as an intermediary between people buying assets (depositors) and those selling them (borrowers). But the big difference between investment and commercial banks is that investment banks do not hold assets on their balance sheets for very long; its a quick-turnover business, at least if done profitably: they want to flip the securities they have underwritten to a buyer quickly to get the margin of profit, as opposed to commerical banks who hold their liabilities (deposits) and assets (loans and other securities) on their balance sheets for a longer period of time.
But what are the implications of this for the financial crisis? Well, the investment banks were the critical link in the securitization chain that spread the risk of mortgage default from the originators of the mortgage to the broader financial system; if the investment banks had not underwritten the mortgage securities from the originators and sold them to other investors (such as commerical banks, pension and mutual funds, sovereign wealth funds, ect) the financial contagion would not have happened...
but why was it all able to go so wrong?