NY Fed chief Timothy Geithner gave the most succinct explanation of what has happened in the banking industry of late. Read it twice. Or three times. As many as it takes.
It is important to understand that investment banks now perform many of the economic functions traditionally associated with commercial banks, and they are also vulnerable to a sudden loss of liquidity. Unlike commercial banks, which rely significantly on deposits for funding, investment banks operate according to a business model in which they fund large portions of their balance sheets on a secured, short-term basis in what is known as the repo market. Because the assurance of access to short-term secured funding on a daily basis is such a critical component of business functioning for these entities, they are vulnerable to the possibility of a sudden pullback in short-term lending, or a reduction in the willingness of investors to lend against certain classes of securities. [Emphasis mine]