It also encouraged an asset bubble, because it was cheap to borrow and this encouraged unsustainable lending. US interest rates kept too low for too long around 2003-2005. This encouraged an asset bubble, especially in US. The problem was that inflation was low and people felt this was the most important target. In targeting inflation, people ignored the asset bubble. (see: Mistakes of Alan Bad Loans. Probably the biggest cause of the current credit crisis. Banks and mortgage companies made a serious of bad loans especially for supreme mortgages.
Basically, people were lent mortgages they had no realistic chance of repaying. Mortgage companies and banks were left with a series of bad debts they had to write off. See: Supreme Lack of Capital reserves. In the boom years, banks pursued a reckless dash for growth. This meant lending a high % of deposits. Therefore, when they suffered bad losses. They had no reserves to call upon. This led to a dramatic drop in bank loans which had ripple effects throughout the economy. Reselling of Bad Loans.
Most of the bad loans originated in the US supreme mortgage market. However, these were rebounded and repackaged into collaborated debt obligations. They were given triple a ratings and bought by banks around the world. Therefore, when mortgage defaults cured in the US, the losses were felt by the whole global banking system because most banks had some exposure to these bad loans. Boom and Bust in Housing Markets. Starting in the US, house prices shot up and then fell rapidly.
Falling house prices reduce consumer spending and consumer confidence. Also banks losses were increased by falling house prices. Asset bubbles and booms are often associated with prolonged recessions (depressions) (see: Boom and bust in US Housing Market[- Who is to Blame? Banks who made irresponsible loans to people who would struggle to repay especially in America) Banks who were irresponsible in pursuing growth at cost of lower capital reserve ratios. Especially banks like Northern Rock, RUBS.