The Bubble

In subsequent weeks, the stock values of many subprime lenders plunged, and others filed for bankruptcy protection. Construction of new homes hit its lowest point in nearly a decade. On Feb. 27, the Dow Jones industrial average fell 416.02 points, the seventh-largest point loss ever.

At the Federal Reserve, officials remained unruffled. They privately calculated that even if subprime losses were severe, the dollars involved would be no more than a blip in the overall economy. As late as June, Fed Chairman Ben S. Bernanke spoke via satellite to a conference of international economic officials in South Africa, predicting, "the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system."

But in financial circles, word circulated about trouble inside one big New York investment bank. Bear Stearns had two hedge funds that invested heavily in securities backed by subprime mortgages. Hedge funds, which handle the money of wealthy investors, are lightly regulated and don't have to report much about their operations to investors. So it was a surprise to Wall Street when the funds appeared on the brink of collapse, forcing Bear Stearns to lend one of them billions of dollars to keep it afloat.

The question in many boardrooms became: What else is at risk?

Chapter VII 'This is a Tidal Wave'

Debate among People's Choice executives gave way to questions about the subprime lender's own survival. The investment banks that had bought subprime mortgages to pool them were now demanding that lenders like People's Choice take back the mortgage loans that had gone into default, arguing that misrepresentations had been made about the borrowers. And lenders had to take them; they couldn't risk further damaging their relationship with the banks.

"Now the whole industry is starting to choke on the volume of loans put back to them," Zimmer said.

People's Choice turned around and tried to sell off the bad loans but took "a huge hit," he said. The company had been scrambling to further tighten its lending standards, getting rid of mortgages with no down payment and requiring borrowers to have stronger credit histories. But "by then, it was too late," Zimmer said. "This is a tidal wave."

Finally, banks that had been lending cash to keep People's Choice in business cut off the company. "When that happens, you're done," Zimmer said. "It's the kiss of death."

People's Choice filed for bankruptcy protection in March 2007. By June, Zimmer was laid off.

In Northern Virginia, things were also unraveling. Kevin Connelly, a mortgage broker at Pinnacle Financial's Vienna office, fielded calls from desperate homeowners. Some had been counting on disappearing sources of income -- family, renters -- to pay for mortgages. Many had been employed in the home-building industry, which was shedding workers in droves. Still others owed more on their mortgage than the home was now worth.

"There was a gross underestimation of the true cost of homeownership," Connelly said.

For most of these callers, he had nothing to offer. "What happened was the values had dropped, the credit scores had dropped, and the loan programs had gone away," Connelly said. "I would hang up the phone and be frustrated that I didn't have a solution."