In a nutshell, banks work like this: People give them money to hold by putting it into checking/savings accounts. Banks then turn around and lend that money to others via loans. Sometimes they use that money to invest for themselves.
A bank’s primary asset is trust. For a bank to work, the consumers must believe that their money is safe with their bank. Otherwise, they will not give their own money to the bank for safekeeping, and the bank would have no money to lend to others or invest. The irony is that banks cannot possibly have the cash on hand to give back to all their customers at once. But, as long as people believe in the bank, and keep their money in the bank, the bank stays afloat.
The problem that we're having now, is that certain banks that lent out a lot of customer’s money in bad mortgages. So, with as many foreclosures that we’ve had, banks have lost a lot of money, and people lose trust in their banks. When people lose trust in a bank, they withdraw their money, creating a “run on the bank” just like in It’s a Wonderful Life. This is what happened to Bair.
The big fear is fear itself. Worst case scenario is that the entire nation would have a loss of trust in the entire banking system. This could cause a run on the banking system, and lead to a chain reaction of banks imploding. This is what happened during the Great Depression.
That’s why the Fed stepped in, and said that they would cover Bair’s bad debts to avoid a big bank’s collapse. It sucks, because the rest of the country is on the hook for Bair’s losses. And, the US dollar is gets weaker when the government prints money to cover bad debts. But, it beats a chain reaction of banks imploding.