Investing in each other's products

My friend in America sent me this explanation on why the banks and stockbrokers have so much money in sub-prime assets.

1. The originating banks were not allowed to hold their own products.
2. They buy each other’s products and used them to increase the value of their earnings.
3. The products are quite complex; no one could figure out how to value them
4. Each separate mortgage has a different set of rules regarding a change in interest rates.
5. Most of the mortgages originate from brokers whose only interest is to earn a mortgage fee.
6. The lenders do not carry out due diligence; they package the loans and pass the risk to the investors.
7. There is a complex set of events which finally lead to this crisis

He told this old story. A buyer got a rotten Herring and complained about it to the broker who sold it to him. The broker said. "Oh that was a trading Herring not an eating Herring.”