What happened to all those people who bought big houses they couldn't afford with loans they never pay back?

No, the banks foreclose and get the house along with whatever payments the owners made up to that point. They don't go to jail because the bank has the property. The banks are having problems because they loaned money to people they never should have loaned money to in the first place. Now they have many overpriced houses to unload and no one's buying.