Banks loved option ARMs because accounting rules allowed them to book the fully indexed mortgage payment as income, even if the borrower made the minimum payment each month. That meant a juicy bottom line, even if cash barely trickled in the door.

Mortgage brokers and loan officers loved option ARMs because they could earn fat commissions on loans that were easy to sell - since they never had  to explain them.

And borrowers loved option ARMs because they could buy their dream homes, rationality be damned.

Option ARMs flourished in boom states like California, Florida, Arizona and Nevada since homeowners could simply sell or refinance their way out of any problems as home values kept rising. Delinquencies remained remarkably low, creating years of "historical" data upon which to base assumptions about future loan performance. 

Back in New York, Bear Stearns pioneered Wall Street’s foray into Option ARMs. The mortgage gurus at Bear figured out how to turn them into highly profitable mortgage-backed securities.

After that, it was a race to the bottom. Bear, Countrywide and IndyMac literally competed for business based on who could buy the loans faster - and with less scrutiny.

When home prices stopped rising, however, it all came crashing down.

Faced with a rising loan balance, higher monthly payments as teaser periods ran out and falling property values, borrowers were stuck. Defaults rose, losses mounted and banks couldn’t unload the paper without taking significant hits. Instead, they chose to hold on and try to ride it out.

We now know how that strategy ended.

As I have written previously, in the face of unprecedented government intervention, the free market has still managed to punish the mortgage boom's worst offenders. Not every guilty party will be brought to justice, but the firms that have failed thus far were deserving of their fate.

To be sure, not every employee at the likes of Bear, Lehman, Countrywide and Downey were culpable, but when the dust settles, the weak hands will have been truly cleaned out. Banks that maintained even marginally prudent lending standards are now reaping the benefits.

This fact gives me hope - hope that despite their best efforts, bureaucrats will always lose in their battle against the free market.