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what happened was the investment banks bundled the mortgages into securities (asset-backed securities). The asset was theoretically the real estate but often was nothing except part of the income stream from the mortgage bundle. These were sold to large investors who borrowed from banks for leverage, essentially buying them on margin in the hopes of selling them later.

Lots of people knew that later might be bad (real estate couldn't rise forever) and bought Collateral Debt Obligations against those ABS where they traded various credit risks of the underlying securities and their income streams. Upper tranche buyers assumed that their income streams would remain solid even in a major recession. At least that's what the models said. So trading those CDO's as securities themselves would have an orderly market with somewhat predictable prices (mainly based on fluctuations in interest rates.

There are other derivatives such as Credit Default Swap where a deep pockets player (e.g. AIG) would collect payments in exchange for insurance on some CDO. But if lots of CDO's lose lots of value that insurance company could be in trouble as AIG was last summer.

What is almost never mentioned by the Paulson-Geithner types is that the CDO's and CDS securities are what is hard to value or downright worthless. These are what is dragging banks down (so-called toxic assets). Not the mortgages. There were only a relatively small number of defaults and the original 700 billion TARP money could have easily paid them all off. Probably 100-200 billion would have been enough to get everyone above water with their interest rate bought down to affordability.

But as I said mortgages were not the issue, derivatives were, which in many cases had nothing to do with mortgages (e.g. a CDS which made money when Lehman folded and defaulted on its bonds). There are literally 100's of trillions in derivatives that presents an overwhelming systemic risk, so TARP was conceived to lower that risk. They quickly realized that buying the worst 700B out of more than 700T was not going to accomplish much, so they used the money to replace lost equity in banks.

That was a losing idea since, for example, the TARP people put 25B into Citi in October which they could have bought outright then for 20B. Then another 25B in December, plus guarantees (default insurance) on 800B of securities that Citi held. After all that, Citi was worth less than 20B in January. Now that banks like Citi are effectively nationalized (govt meddlers calling the shots), nobody else is going to invest in them (unless paid side channel to do so - see PPT below).

Bottom line is that toxic securities far outweigh any ability to buy them at the present. The other thing I mentioned was the Plunge Protection Team set up to prevent large collapses in the market. The problem with doing that is like putting out all the small fires which sets you up for one big huge fire later. Just like in Australia, that fire is now. But our PPT is still out there, even putting out small back fires that would help contain the main fire (e.g. suppressing gold prices) because that's all they know.