Final answer:
The large number of defaults on loan-backed securities heavily impacted securities firms and investment banks as they suffered major financial losses due to the devaluation of these securities and consequent housing market collapse, leading to the 2008-2009 Great Recession.
Step-by-step explanation:
The large number of loan defaults negatively impacted securities firms and investment banks primarily because these institutions held a large number of loan-backed securities. Loans were securitized and sold as mortgage-backed securities (MBS), which meant that when borrowers failed to repay, the institutions holding these securities suffered significant financial losses. Additionally, the housing market collapse caused these MBS to drop in value, amplifying the losses. The collapse of housing prices also resulted in a reduced net worth for homeowners, creating a negative wealth effect. These issues, coupled with a lack of confidence in financial markets, led to a drop in lending and spending, exacerbating the economic downturn and contributing to the 2008-2009 Great Recession.
When housing prices dropped, borrowers found themselves owing more than their homes were worth, a situation known as being 'underwater'. Banks and securities firms had believed that they had spread out their risk by investing in securities based on mortgage loans from across the country, but they discovered that the securities were interconnected and far riskier than anticipated. As banks faced their own financial difficulties, they began calling in loans and had less capital to lend, leading to a credit crunch. This affected individuals and businesses, as loans became scarce and expensive, putting further strain on the economy.