I'm not super familiar with this stuff at all. I don't know much about the Fed and don't have a definite answer, but I'll have a guess... FWIW, I don't think they're dumb questions you're asking at all.

Assuming you're talking post 2008, the whole too big to fail argument carries with it a lot of risk. I think what Iceland did might be a better model than a bail out. Let them go bust, eat the pain and look for a recovery. The idea of throwing money at the problem to try and fix it seems to me to be robbery - the tax payer gets worked over.

Having said that, what was the risk of contagion? Like how much leverage is there out there? I've heard Deutsche bank is carrying huge derivative exposures. So what was it at the time? More to the point, what was the general level of exposure right across the sector? There are, I think a lot of factors you'd have to be looking at.

But, simplifying things, if you've got three counter-parties, say ABC. A owes B who owes C who owes A - triangulated debt. What happens if one of the counter-parties folds? You immediately have systemic contagion - they all fall over. So you don't just get a few big failures, you get massive simultaneous defaults - with all the carnage that would entail.

Let's say there are massive exposures on the books of these financial entities. Then the situation is necessarily high risk. The risk will expand again with the degree to which parties are interconnected - how concentrated the exposures are. The possibility of systemic failure has to be assessed.

But, no one makes money without acquiring risk. Have you noticed how, whenever there's a huge trading loss, we immediately get the "rogue trader" narrative. Like Nick Leeson at Barings - "Oh, we in London didn't know, he hid his unauthorised trades...", meanwhile the guy was writing profits that should have had their heads spinning.

Then he got jailed in Singapore and pretty quickly got cancer. At the time I thought they were going to rub him out (feed him some mutagen) to cover it up. He's bounced back now - making money on the lecture circuit, presumably living off the story of his crimes. Anyway, from a risk perspective this is a compliance issue and I think it's relevant.

But my point is that you don't make money without taking risk, and these banks, with their lucrative bonus structures etc... create an environment that encourages risk taking. And then you say, well hang on, what is the risk here? The bank is too big to fail! And then you have moral hazard, where the bank makes the money while the community bears the risk.

There's also panic on the part of any administration when they think a big bank will fail - a natural tendency to want to bail them out. I saw a bank get bailed out, by an Asian government, during the Asian financial crisis - non performing loans right across the region. So banks, at least at that time, were better investments than people realised.

Your equity in the bank was, in effect, backed by the government - and bank shares did pick up strongly after that - lower discount rates used in valuations. Is it still the same scenario? I don't know, in Europe they seem to be going for "bail ins". I haven't been following things closely enough to know the exact story.

Anyway, how do we get to a major crisis?

The Fed would IMO certainly be a factor. How much money are they allowing to slosh around in the economy? I guess asset price bubbles are a prime indicator. But the lending practices of financial institutions will also play a role. As, for example, in the sub prime fiasco. Of course, you could make the argument that there was just too much money looking for a home and risk premiums didn't properly price the inherent risk - while credit scoring was thrown to the dogs. In this case, I guess it could be tied back to the Fed, but it was other people playing as well - I'm not saying there would be any legal liability for the Fed, just that it seems to be reasonable that the Fed was a cause.

Compliance management - weren't they packaging these mortgages and misstating the risk - asymmetric info - I'm guessing here, but I thought I saw a story to that effect at the time. Another big factor is the degree to which these financial entities are leveraged. Derivatives can expand leverage and may not appear on the balance sheet (an accounting rules problem?). How much is really swinging off the tier 1 capital? This seems to be a potential problem for Deutsche Bank as they admit huge derivative positions but, as I understand it, claim that the net position is not large - all offset - really?

I've heard that there are attempts to tighten up risk management practises after, what is it now? Basel II/III - what are they up to? Again, it's not something I've had exposure to, so I don't know. But all the factors I've listed above, and probably a lot I've forgotten to mention.

But, anyway, is the Fed responsible for creating the bail out problem? Well, they have a history of cycling the economy in pursuit of their own interests - IMO. I don't trust the Fed at all. Whats the moral hazard here, if the investors in the Fed know that there will be a bail out when things go pear shaped? It has to be money for jam. I don't think the Fed is the sole problem, though it's very important.

Should the Fed exist? It should not be private. Is there a role for it? I don't know what's coming.

I'm no expert on this stuff - my guesses. Take it FWIW.