##ably low level that is not consistent with our long - run price stability objectives. monetary policy works with long and variable lags, so overheating is a risk. if overheating did occur, the fomc might need to tighten monetary policy more aggressively in order to keep inflation from significantly overshooting its 2 percent objective. in such circumstances, the risk of a recession would probably climb significantly. in the past, it has been very difficult for the federal reserve to engineer a soft landing for the economy when it had to tighten policy aggressively in order to keep inflation in check. historically, once the unemployment rate rises above a small threshold of 0. 3 to 0. 4 percentage points, the next stop has always been a full - blown recession. i very much would want to avoid such an outcome. a long - lived economic expansion is always desirable, but especially so in the aftermath of the financial crisis and great recession. the second risk of delaying lift - off and normalizing more slowly is that the low level of the federal funds rate may be distorting financial markets and increasing financial stability risks. i don ’ t think this has yet occurred to any significant degree, but it is a real risk that we should continue to monitor closely. i see the risks right now of moving too quickly versus moving too slowly as nearly balanced. the weight that one puts on each undoubtedly influences one ’ s views on when the time will bis central bankers ’ speeches be right to begin to normalize monetary policy and the appropriate short - term rate trajectory thereafter. finally, in conclusion, a few words about the importance of financial conditions in thinking about the future path of short - term interest rates. monetary policy does not work directly on the economy, but instead works through its effect on financial conditions. by financial conditions, i mean all those financial factors that weigh on spending, saving and borrowing decisions. financial conditions include the level of the stock prices, the level of short - and long - term interest rates, the size of credit spreads, the foreign exchange value of the dollar and factors that weigh on the availability of credit. if the linkage between financial conditions and the short - term interest rate controlled by the federal reserve were stable and predictable, then there would be no need to also monitor financial conditions. but the linkage is not stable and predictable. sometimes financial conditions loosen or tighten in response to economic developments independent of our monetary policy decisions. at other times, the response of financial conditions can be much larger

a sharp rise in delinquencies and foreclosures as the bust has played out. the fact that these poorly underwritten loans were used in the construction of very complex collateralized debt obligations or cdos, with risks that were not well understood and grossly mispriced – made a bad situation even worse. investors who thought they had purchased safe aaa - rated assets found that these assets were very vulnerable to a housing bust and that the ratings were unreliable predictors of the risk of loss. the poor performance of these securities, in turn, made investors much less willing to invest in structured - finance products more generally. secondary market liquidity evaporated, which exacerbated the difficulty in valuing the securities. this made the market even less attractive, causing risk premia to widen further, which only worsened the valuation problems. as this process unfolded, the result was a virtual shutdown of the securitization market for residential mortgage assets not backed by the federal government directly ( ginnie mae ) or implicitly ( fannie mae and freddie mac ). the subprime and the alt - a mortgage markets, which relied heavily on the securitization process dried up. of course, this just reinforced the downward pressure on housing prices, which, in turn, led to increased delinquencies and foreclosures. this deterioration undermined the value of the securities further. it was a vicious feedback loop in action. the poor performance of highly - rated mortgage securities caused investors to begin to shun securitizations more generally. the shutdown of the securitization markets led to significant pressure on bank balance sheets. banks could no longer securitize non - conforming mortgages or the collateralized loan obligations associated with leveraged buyouts and other private equity activity that they had financed. moreover, bank backstop liquidity lines were triggered as sivs and conduits could no longer issue asset - backed commercial paper. finally, banks took large mark - tomarket losses on their trading books and had to increase their loan loss provisions. as the crisis continued into 2008, the squeeze on bank balance sheets intensified. this was driven by several important developments. first, the demise of bear stearns increased the pressure on the other broker dealers to deleverage. they did this, of course, by becoming less willing to lend funds to their counterparties, such as hedge funds, and by shrinking their trading books. in