The definition of a recession is two quarters or more of negative growth. So technically, we don't know if we are in a recession yet because the last quarter we have info on was the fourth quarter of 2007 and because we had positive growth in that one, we won't know until into the summer (2008,Q3) if we are in a recession right now.
The causes for this have to do with sub-prime mortgages. The fault is with both borrowers and lenders. Banks make money by loaning money to people and businesses. Sub-prime means that the borrower is more unqualified for a loan (credit history isn't good enough).
When rates of interest rates were really low (the Fed lowered interest rates after the dot com bust to avoid a recession), the banks got greedy and lent to sub-prime borrowers who couldn't afford the loans. They then packaged some of these loans into securities and sold them to investors through investment banks. This securitization of loans allows banks to pass on the default risk to others.
It turns out that it wasn't known how risky these securities were. A lot of borrowers couldn't afford higher rates on their adjustable rate mortgages and when the rates went up they defaulted on their loans. This makes the securities worthless. A lot of pension funds, hedge funds, etc invested in these and now they are seeing losses. Bear Stearns was heavily involved in these securitized sub-prime loans through two hedge funds they operated and now it's bust. Banks that made loans like Country Wide Financial were among the first to be affected.
In addition and of equal importance is that the banks are loosing money and now see risk everywhere. They will be less able to pass on the risk through securitization because investors now realize how risky the securities are. They will now increase their standards for borrowing which will make it harder for customers to get loans. This restricts the amount of money in the economy and it's a bad thing because credit helps the economy grow (think loans for new and expanding businesses). To respond, the Fed will lower interest rates to give banks more room to make loans. This creates other situations such as increasing inflation and a weakened dollar.
Inflation is the bigger concern of these two because one of the Federal Reserves goals is to maintain stable prices (control inflation) while achieving maximum employment. The Fed generally thinks a little inflation is okay (1.5-2.0%) if it can avoid a recession. The problem with inflation is that it destroys savings (hurts the elderly and people on fixed incomes). Lower interest rates also make oil more expensive.
So in conclusion, you have the sub-prime loans (caused by banks that wanted to make money and didn't see the risks) and you have the amount of credit available drying up because the banks now have less ability to make loans. The economists at a lot of these companies knew that there would be problems with the sub-prime loans, but the upper management didn't listen because when you're making money it's hard to stop. I think the Fed is trying the best it can.
I think the government will have to increase the regulations on the banks and mortgage companies because the financial services industry created this mess.