The U.S. economy took a decided turn for the worse during the first quarter of 2008. The problems in subprime mortgages disrupted the mortgage-backed security market and led to a drop in house values which has shaken people’s confidence and slowed consumer spending. Banks became more cautious in their lending practices and many companies found it difficult to get short-term funding. By the end of March, as the turmoil in the capital markets culminated with Bear Stearns facing bankruptcy, factory production and retail sales falling, employment shrinking, and household income slowing many economists were saying that the economy may already be in a recession.

So how did we get here? The answer is open for debate, but many believe the seeds were sown in the aftermath of the terrorist attacks on September 11, 2001. In an effort to maintain Americans’ optimism the Federal Reserve dropped the fed funds rate in a series of moves to 1.0 percent. This encouraged banks to lend and inject liquidity into the economy. For the next five or six years the Fed continued to pump liquidity in the system. This kept the economic expansion going, but lower interest rates also led to a greater demand for higher-return, higher-risk investments. Investment banks met this demand by packaging risky mortgage loans into high yielding investment securities for investors.