Sicilian Babe and Don Sicilia are spot on and both answers summarise the UK situation as well. It's such a general question that I doubt even collectively we'd cover all the areas but here's my angle:
Due to a little aquisition that's going through, I actually work for what will be the largest bank in the UK (currently the only UK bank within the top ten of the worlds safest banks). I only have experience with personal banks rather than investment banks (Lehman Bros) though.
A couple of years ago, whilst working in the mortage end of the bank (within a sales retention team), I wondered why we weren't offering the best deals in the market. Why were we passing on the buy to let, 100% (and more frightingly 110%) mortgages, or higher risk borrowing that so many banks were eager to gain? It made my job harder, knowing someone was leaving the bank to chase a better rate with Northern Rock (now nationalised to prevent it going bust).
Instead we took a prudent approach, and right now it's paying off.
I can't speak for the US, but within the UK the safest banks will only invest (read mortgage lending) money that is deposited within their bank by customers.
The trouble is, with some banks (particularly Northern Rock), is that they lend money that they don't have. They raise the funds by selling the debt on to the wholesale money market (for example Lehman Brothers). So now as those funds are not available as credit is tightening, these type of banks find they're short of funds.
Luckily my work are not too exposed to the Lehman Brothers crash - but there's plenty of others within the UK that are, and obviously it's affecting the US.
Individuals have to take a lot of responsibility for themselves as well. Anyone taking out a mortgage for more than 95% of the value of the property are taking an incredible risk. These products became very popular only 3 or 4 years ago. Although you'd be lucky to find one now. To expand of Don Sicilia's point, if you take a £100k mortgage on a property worth £100k (a 100% mortgage - loan to value is equal), and that property's value decreases by 10%, so it's now worth £90k. If you're ever in a situation where you're getting reposessed (maybe interest rates are increasing or inflation is increasing - you can't meet the payments. Both of these situations are prominent in the UK which i'll get to in a second), suddenly you've paid back the £90k the property is worth - but you're also in a position where you're liable for an additional £10k to pay the rest of the borrowing.
So, interest rates:
Again, can't speak for the US or Federal Reserve but the Bank of England are in the unenviable position of trying to curb inflation, yet get the economy back on track. To keep it simple, let's attribute inflation to the cost of oil increasing. We have very little, maybe no control over that, so traditionally when inflation is increasing the Bank of England would increase interest rates to stop public spending (this works as the cost of borrowing goes up - less people likely to borrow, and also the benefits of saving increases). If people aren't buying, producers cannot keep costs high and thus decrease them to curb inflation.
But this method hinders the economy - businesses certainly suffer. Also no one can get on the property ladder and mortgage borrowers find themselves paying more. To boost the economy, the Bank of England would reduce interest rates. But to do this would raise inflation through the roof.
With the current economic climate, the Bank of England can't afford to either raise interest rates (to curb inflation) or lower them (to boost the economy). It is literally being stuck between a rock and a hard place.
I think I was sober when I started this post, I can now say I'm not. This must be my longest ever post. Sorry to bore everyone, but I'm nuts about this sort of thing.
