It's been a financially scary day - the scary stuff isn't over yet, either

It's been a wild weekend followed by a bad Monday in the financial markets. Lehman Brothers was forced into bankruptcy when Treasury Secretary Paulson refused to hand over $billions in taxpayer dollars to save them, and the nation's largest stock broker, Merril Lynch, was folded into Bank of America. Of the five New York-based securities firms that dominated Wall Street in January, only two, Goldman Sachs Group Inc. and Morgan Stanley, remain today. Bear Stearns is gone, Lehman Brothers is in bankruptcy until it can be sold off, probably in pieces, and Merrill lynch has become another branch of Bank of America.

The world's largest Insurance Company, American International Group Inc (AIG) is on death watch, and the market is betting against the survival of the nation's largest Savings and Loan, Washington Mutual. This is the most massive restructuring of Wall Street since the Great Depression.

Today the stock markets reflected a lack of belief that the problems are over. The DOW Jones index dropped 4.42% and the broader S&P index dropped 4.71% today. The Wall Street turmoil spilled over into drops in the stock markets of Japan and South Korea.

The deal that Fed Chief Ben Bernanke and Treasury Secretary Henry Paulson worked out Sunday night is a patch on the set of problems. A lot of people are wonder how well it will last. Part of the deal according to Ian Welsh was to add more money to the system to be a backup against future problems. "Ten major banks kicked in 70 billion into a fund they can borrow against if they have problems and overnight the Fed added 70 billion to the banking system's reserves." In addition, the fed is going to kick in a 75 billion dollar lending facility led by Goldman and Chase. But that's not enough.

Bernanke and Paulson are really going all in on this, they're letting banks play with depositor money:

The Fed added that it was suspending a rule that normally prohibits deposit-taking banks from using deposits to help finance their investment banking subsidiaries to allow them to fund activities normally funded in the repo market on a temporary basis until January 30 2009.

This is a dangerous game, because instead of firewalling that money away from investment subsidiaries, it allows banks to gamble that with depositor money they may be able to turn it around. This was exactly the sort of thing that Glass-Steagall was designed to make impossible - banks to not be in the brokerage business, insurance companies not in banking, and so on. Glass-Steagall was partially repealed in 1980 (part of what made possible the Savings and Loan fiasco), further parts in 99 under Clinton, and now the Fed has violated the fundamental principle that banks shouldn't be gambling with depositor money. Because, be real clear, if you don't really know how much in the hole you are, or how much further you could get, lending money to the unit that's in the hole is gambling.

It's also putting the FDIC (the organization which insures deposits) even more on the hook, and the FDIC does not have infinite money except in the sense that the Treasury can lend it infinite money. At this point the FDIC has about 50 billion. Banks have about 4.7 trillion in insured deposits. Yes, that's a bit of a gap.

When the FDIC runs out of money, then the taxpayers get tapped for more.

So Bernanke and Paulson are gambling without knowing what cards they hold in their had, and they are gambling with taxpayer money if they lose their bets. If Bernanke and Paulson win the bet, the taxpayers get none of the winnings.

That may be the best deal that is possible right now because this bail-out has been an emergency ad hoc operation put together at the last minute. Six months ago after Bear Stearns disappeared everyone was saying that there needed to be a plan in place to liquidate other companies in an orderly manner if they went under, and no one did squat. So the problem popped up again, twice as bad as before with no better plans in place to resolve it. There are doubts whether Goldman Sachs and Morgan Stanley can survive as independent entities.

So everyone is waiting for the markets to open tomorrow morning to see what happens next.