Significance of bank failures

For the past year or so, bank stocks have been keeling over one by one, and it's reached a climax (for now) today with the failure of Lehman and Merril Lynch.

I'd like to ask the smart people reading this board what it means. It seems to me like the entire modern banking system is systematically failing in some way. Is it due to investment banks using focusing on derivative instruments to make money instead of traditional instruments? Is it bad policy by the Fed? Is it some other reason?

Obviously, I believe this might be a good thing, allowing more sound decisions to be made in the future.

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- It's partly because they make left-skewed bets
- Leverage doesn't help (and the Fed helps leverage)
- Most business fail, big banks are no exception. We are often under the impression that bigger should mean safer, but it's really about assets and liabilities.

A good thing?

Do you think banks could start competing on low reserve fractions? Or would captured regulators do the same thing the USDA did with Creekstone Farms and require small banks to be just as risky as large banks? How can "bank failure" translate to "bank regulator failure"?

Do we need to wait until the dollar crashes before the economy is released from federal control? Will even that be enough, or will military force (including militarized domestic police forces) be used to prevent other reserve currencies from competing?

Should I take the 10% penalty hit and cash in my IRA to pay off my mortgage?

Like you, Jonathan, I have a lot more questions then answers...

Do you think banks could

Do you think banks could start competing on low reserve fractions? Or would captured regulators do the same thing the USDA did with Creekstone Farms and require small banks to be just as risky as large banks? How can "bank failure" translate to "bank regulator failure"?

What do you think the FDIC does ?

As far as I understand, it

As far as I understand, it all started with the property bubble. The chain of causation is somewhat complex and esoteric, so bear with me.

An unprecedented rise in housing prices led banks to make mortgages to very marginal borrowers. These borrowers did not have the resources to afford the mortgages unless housing prices continued to rise. Once home prices stopped rising, these mortgages defaulted in numbers that were far greater than any bank predicted, even in their wost-case scenarios. Many mortgage lenders went under, home prices continued to fall even more, and soon even high-quality mortgages started to experience defaults in greater than expected numbers.

The first firms to get hammered were the home lenders. Then anyone that held a large position in mortgage derivatives went under. Mortgage insurers and servicers were also wiped out.

These firms were heavily leveraged. In other words, financial firms borrow money from one party and lend to another, with very little of their own money invested in the loans. Soon, the people that lend to financial firms started to feel the bite and tightened their lending standards. This left many financial firms without the resources to run their day-to-day operations. Firms outside the mortgage space started to get hit.

That's when the Federal Reserve stepped in and started lending money to financial firms in order to prevent a massive chain of failures. Similar reasoning is behind the Fed's current bail-outs. They are letting equity holders get soaked but guaranteeing debt holders. They are trying to instill confidence in lenders that they can conduct business as normal and continue lending to financial firms.

I left the industry in April 2008 and I haven't followed as closely since then, but my story still feels right. I could be wrong. I am not sure about the specifics of the events at Merrill Lynch and Lehman Brothers. Fannie and Freddie looked to be put under by bad mortgages.