Higher delinquency rates on sub-prime mortgage loans triggered a wave of bankruptcies of sub-prime mortgage lenders. As bankruptcy filings by mortgage lenders mounted, unnerved investors began draining liquidity from financial markets. With banks holding on to their cash to cover losses, credit markets started to seize up. Even creditworthy borrowers began experiencing difficulty in borrowing.
Firms/ households cut back on investment and consumption, causing a slump in economic activity, precipitating a recessionary cycle. Moreover, since the loans were securitized and sold to other investors as credit derivatives, the defaults in the mortgage lending market spread to the wider credit markets, multiplied several-fold by leverage.