My cousin was VP of a small and conservative midwestern bank in those days. We did not meet often, but 2002 to 2010 we together watched the slow motion freeway pileup. Once or twice a year discussing the unfolding insanity over coffee at our business meetings. A retired economics professor & old friend added his perspective "Carl, the trouble with accountants is they think their numbers have something to do with reality." At the time I wondered where the obviously due recession was in 2005. The construction industry was 'Flame Out' but the financal industry attitude was all rainbows and unicorns. I'm convinced that had the necessary shakeout come in 2003-4 most of the long term damage of 2008 would have been avoided.
Accountants have a place, but as your pal the economist pointed out, they have to stick to the absolute facts of what is in the numbers, not get creative. He remembers that accountants are the ones who, when asked what the company profits were for the year, will ask what the owner wants them to be. Unfortunately accounting has too often become a branch of management magic. Too much moving 'funds' back and forth on paper. (The less said about the financial sector the better. A massive
Agency Problem. Too much is set up such that maintaining confidence (and therefore "helium") is necessary to hold it all up.)
You are right, I think, that a shakeout in construction (at least residential), and a few blips in housing markets or even the failure of a major mortgage lender or two, would have headed off a lot of pain. If nothing else it would have been a smaller house of cards to collapse. As for what held it all up - maybe the same belief that the value of land holdings would rise fast enough to rescue everyone?
I spent the late 1990s as a market housing analyst and we saw the US housing crash coming a long way off. Every time there was a loosening in mortgage rules we could sense the increased scope for brinkmanship - and that was without the deliberate fraud that was taking place behind the scenes. Like most economic movements, the more the turn is delayed the sharper the turn will be.