http://www.nytimes.com/2008/03/15/business/15risk.html?hp=&adxnnl=1&adxnnlx=1205578973-vLads8Aq19ssGOgvpI+PWA
Behind Bear Stearns Rescue Plan, a Wall St. Domino Theory
By JENNY ANDERSON and VIKAS BAJAJ
The Federal Reserve’s unusual decision to provide emergency assistance to Bear Stearns underscores a long-building concern that one failure could spread across the financial system.
Wall Street firms like Bear Stearns conduct business with many individuals, corporations, financial companies, pension funds and hedge funds. They also do billions of dollars of business with each other every day, borrowing and lending securities at a dizzying pace and fueling the wheels of capitalism.
The sudden collapse of a major player could not only shake client confidence in the entire system, but also make it difficult for sound institutions to conduct business as usual. Hedge funds that rely on Bear to finance their trading and hold their securities would be stranded; investors who wrote financial contracts with Bear would be at risk; markets that depended on Bear to buy and sell securities would screech to a halt, if they were not already halted.
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Compounding the problem, some big investment banks this week stopped accepting trades that would expose them to Bear Stearns. Money market funds also reduced their holdings of short-term debt issued by Bear, according to industry officials.
“You get to where people can’t trade with each other,” said James L. Melcher, president of Balestra Capital, a hedge fund based in New York. “If the Fed hadn’t acted this morning and Bear did default on its obligations, then that could have triggered a very widespread panic and potentially a collapse of the financial system.”
Already, investors are considering whether another firm might face financial problems. The price for insuring Lehman Brothers’ debt jumped to $478 per $10,000 in bonds on Friday afternoon, from $385 in the morning, according to Thomson Financial. The cost for Bear debt was up to $830, from $530.These rescue plans take time to put together - if Lehman Bros and maybe another bank go belly up in short order the fallout won't be containable.
"collapse of financial system" means that ordinary economic activity would become very difficult.
Maybe a reform would be to prevent any one bank from becoming "too big to fail." Ha! Like that would ever happen.