Setting the Context At the beginning of the 21st century, things looked extremely bleak for the US economy. The dot-com bubble left major technology companies – and their employees, in complete financial chaos. This stock market crash caused various companies to lose over $5 trillion in market value over the period 2000-2002. Furthermore, the events of September 11th accelerated this recession. While the $40 billion insurance loss was one of the largest insured events, it doesn't even compare to subsequent events that occurred. Most major US stock exchanges closed (even the London Stock Exchange and various others around the world), airlines and aviation suffered increased costs due to grounded flights, and huge losses were suffered in the tourism sector that employed 280,000 people in New York alone. Overall losses amounted to hundreds of billions. Subprime Mortgage Collapse In response to these catastrophic events, the Federal Reserve began slashing interest rates, with the federal funds rate falling to 1 percent in 2003. As lower interest rates continued to become the norm , the real estate is starting to look much more attractive as many homebuyers were able to purchase homes that offered low introductory rates and minimal upfront costs. The vast majority of these buyers were betting that they could refinance their mortgages at lower rates thanks to price appreciation. However, house prices soon stopped increasing at a breakneck speed. When home prices began to decline in early 2006, many homeowners simply couldn't refinance to lower rates. As interest rates slowly rise, monthly payments on adjustable rate mortgages have increased. Many homeowners found that they could not afford such high payments and were simply forced to default on their loans. Mortgage-Backed Securities So how did these events affect the investment banking industry and ultimately Campbell and Bailyn's operations? Before the crisis, a new financial product was launched on Wall Street: mortgage-backed securities. The concept and flow of these asset-backed securities were quite simple: 1) An originator (who issues the mortgages) pools the mortgage cash flows into a large pool. Within this pool there may be hundreds of individual mortgages.2) The originator sells this package to an investment bank.3) The investment bank requests that the individual tranches of this pool be analyzed by an investment agency reputable credit (Moody's, FitchRatings) and then assign a risk level.4) The investment bank sells these individual tranches at variable prices to institutional or retail investors depending on the riskiness of the debt.