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Warren Buffet calls them 'financial weapons of mass destruction' The toxic alphabet soup of derivatives - SIV's CDO's, CLO's , ABS & SPV's etc.

This alphabet soup represents the highly leveraged risky bets the banks made in the past decade. In addition, the Rating Services gave this toxic soup of derivatives triple AAA ratings.

It is now known that the rating services, Moody's and Standards & Poors, were erroneous in rating this junk so highly. They did so because they were paid by the same banks to do so. It sounds insane and it is insane, but thats what happened.

Now the banks have lots of your money into these financial weapons of mass destruction that are rated AAA but are really CCC or worse. However, the banks are still allowed to show this junk on the books as AAA rated or not show it at all.

Why does this rating or disclosure on the books matter? Because the banks are required to maintain a minimum of 4% cash reserves on risky assets that are on the books for financial investments rated below the AAA rating. Well, many Financial Weapons of Mass Destruction are not even on company books or if they are then they are still rated as AAA and not CCC or perhaps their real risk rating is even worse.

The outcome is that the banks have no minimum cash reserves set aside to cover this risk.

Now you can understand why the banks do not trust each other or lend to each other, why we have a credit crisis and why the Feds (umm you the taxpayer) are lending them money. What they don't know is how much of these financial weapons of mass destruction each other is holding.

It is musical chairs, no bank wants to get stuck with this toxic soup and to make matters worse the risk is not very visible, so bankers hold their cash and lending grinds to a halt.

This credit crisis is so bad that changes in accounting rules that are meant to shed light and transparency to the problem are being delayed a whole year. This is so bad that the Feds have bailed out secondary banks/brokerages for the first time since the GREAT DEPRESSION. This is so bad that the Feds are willing to debase the dollar and practically jeopardize the dollar as the reserve currency. This is so bad that inflation and recession takes a back seat to bank liquidity. This is so bad that banks do not trust each other and primary banks will not lend to secondary banks because they are afraid of who is holding the "financial weapons of mass destruction."

So, the FED has to step in to unlock the credit crunch and lend money to the Bear Sterns of the world and lower the rates at which banks borrow.

In the end Ben Bernanke said it best, 'the market needs to re-price risk' and 'there will be bank failures' - on national TV and as testimony before the senate.

When this happens the markets will crash. Equities, Gold, Silver, etc will devalue. Good stocks and commodities will be sold off with the bad stocks because the banks will need to raise cash in order to meet that magical 4% cash reserve requirement on the risky financial instruments they hold (which is pitifully low compared to historic rates and the rest of the developed world.)

So, What about tomorrow's Fed Action? Well, the credit crunch has eased a tad due to past Fed action and the delay of changes to the accounting rules that would have made the problems more visible to everyone.