"Default rates estimate the probability of getting your money back; interest rates how much you get paid for taking that risk. Banks and dealers made gobs of loans valuing them way too high because they under-estimated default rates and over-estimated the interest rates they'd receive (the bank gave full value to the paper assuming the borrower would successfully be able to pay higher rates when the lower teaser rate converted to a higher fixed rate).
"So all this paper was carried on the books at a high price: The banks showed profits by marking up the value of the paper.
"That brings us to our paradox. Now we know that those variables were fallacious: higher default rates and lower interest rate assumptions are forcing those banks to write-down the value of those loans. … If banks assume higher interest rates so they get more cash over the life of the loan, they must then assume higher default rates for those go up when interest rates, the cost of a loan, goes up."
http://www.minyanville.com/businessmarkets/articles/todd-harrison-midterm-elections-quantitative-easing/11/2/2010/id/30895
And, if interest rates on a given loan goes down, the default rate goes down. The rate which the bank makes, net of defaults, improves. Just lower the mortgage rate on exisiting loans!
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