Countrywide and other sub-prime lenders made a big bet that was not directly related to the quality of the borrowers. The bet was on the continued rise of real estate and not on the quality of their lending standards. While they may not have stated that explicitly to their shareholders, the bet was that the increasing value of real estate would bail out any lender problems. This could happen three ways.
If the borrower sold the property at a higher price, the lender wins. There were prepayment penalties in the loan agreements, so the lender got some of the upside from a flip of the property. The lender would also get to finance another transaction.
If the borrower defaulted, the lender would take the collateral and gain from a flip in the real estate to another buyer. It did not matter if the quality of borrower was poor, you had the collateral. As long as the price appreciated by more than the cost of foreclosure, the lender would win.
Higher inflation that drives interest rates up would not be a problem. The collateral goes up. If you believed that inflation was going to make a comeback and you were writing adjustable rate mortgages, you would be ok. Real estate lending would be good business.
Only one problem, if the value of collateral goes down fast, the lenders lose. Holding collateral should be the last resort. Who would expect that? It is not like this is a “Black swan” problem. We have seen real estate decline. The combination of the S&L debacle with a recession led to a languishing real estate market. The worst case scenario would be a real estate decline without a recession, a fall in housing under the weight of too much building and affordability that got out of control. Lending is not supposed to be an investment in collateral, but these lender were will to play in the "secured lending" market knowing that they were going to make their profits base don the benefit of rising real estate. It is turning out to be just what was expected but at the wrong time.
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