Interesting post, MGshaggy. I'll have to look up the alphabet soup terms, though
Sorry SilverBullet, here's a few...
GLBA = Gramm Leach Bailey act
CRA = community re-investment act
CDO = collateralized debt obligation
CLO = collateralized loan obligation
ABS = asset backed security
CDS = credit default swap/default swap
IB = investment bank/investment banking
MBIA, AMBAC = companies that provide insurance on bonds
A huge part of the problem as I see it was the deregulation that came as part of the GLBA. Glass-Steagall was enacted in response to the great depression and created the FDIC. It also created seperations between banks, IBs, and insurance companies to keep them from getting too involved in each other's business. As I understand it, the reasoning for the seperation was to protect retail banks (and the FDIC insured deposits they held) from losses generated in another division of a financial services conglomerate. Banks have to meet reserve requirements set by the Fed, while other parts of the financial services industry do not. Thus under Glass-Steagall the FDIC insured deposits would be somewhat more protected from huge losses in another part of a company like Citi or Wachovia, such as their IB division.
Take AIG for example. Their primary line of business is as an insurance company. The$100bn+ losses they've sustained have all come from a small division in Endland writing credit default swaps (CDS). While a CDS looks a little like an insurance product against a default on a financial instrument such as a CDO, its not pure bond insurance like a company such as MBIA or AMBAC would issue. Additionally, one can get a CDS against a bond not even owned by the CDS holder making it far more speculative like an investment. Now if AIG had also been into retail banking, the losses from their CDS plays would be placing strain on their capital reserves and their ability to meet their reserve requirements and depositor demands for their money. If the company couldn't meet those demands, the FDIC is then put at risk. As it turned out AIG's losses still put the FDIC in jeopardy because AIG had a huge book of CDS, many of which were held by banks. Had AIG been allowed to fail, the losses would have spilled over to many banks which would have sunk quite a few (so FDIC would have had to come to their rescue).
What I think many people take for granted and forget about in this mess is the importance of FDIC. When people talk about ridiculous things like giving the $700bn to every taxpayer as a stimulus check, they don't seem to realize that if the bank thats holding their money fails and FDIC is depleted, not only is that stimulus money not worth the paper its printed on, but their existing savings/deposits could be wiped out. Further, if the FDIC fails and the government can't satisfy depositor demands, it will be seen by the international community as a sign the US is a credit risk. That will lead to far less investment in US treasuries by foreign investment such as sovereign wealth funds, and that in turn, will have an enormous impact on the ability of the US government to function and remain a superpower (think Russia in the 1980's).