The Fed isn't saying, exactly. But the safe bet is that Greenspan believes U.S. banks are in trouble. Big trouble. Maybe on the brink of a disaster to rival that of the S&L crisis (and subsequent government bailout) of the late 1980s. "The Fed did an internal investigation to see how much exposure the banks had to hedge funds and other high-risk investments," says TIME senior economics reporter Bernard Baumohl. "The cut was a clear signal that conditions are more severe than most of us realize."
In the '80s it was junk bonds; this time it's derivatives. Buying a derivative is taking a bet -- called an option -- on the price of a stock at some future point. The plutonium of the financial world, derivatives are complex financial instruments that, in steady economic times, can churn out megatons of money for investors. Bet badly, though, and you get a meltdown. When Long-Term Capital Management, a high-risk, high-rolling hedge fund based on the formulas of two derivatives Nobelists, went belly-up last month, Greenspan realized that the damage wasn't restricted to the brandy-and-cigars crowd. Banks and financial institutions were deep into hedge funds, and when Merrill Lynch or BankAmerica takes a $100 million hit, a lot of ordinary folks -- from bank customers to businesses to a homeowner looking to take out a second mortgage -- get contaminated.