With an I/O loan, you’ll never have equity without appreciation. So you’re automatically speculating on appreciation if you go I/O, otherwise you’d rent which is much less risky. Your friends were simply speculating in two different markets at once — with their down payment money in something else (stocks?) and housing using someone else’s money. If times got tough they were betting that they could refinance their debt obligation, perhaps converting their stocks to a down payment at that point.

I’m not saying it never makes sense to use I/O, but those loans are best used by the wealthy — they have the possibility of converting other wealth into a downpayment and going fixed-rate conventional if necessary, or selling and taking the loss. They are still speculating, but in a way which is only risky to themselves.