But the Federal Reserve had already started raising short-term interest rates, flattening the yield curve, the difference between short and long rates. (Since banks borrow short and lend long, their margins are higher when the curve is steep.) When this began eating into lenders' profits, they reacted by pushing subprime rates back up.

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So, what a bank actually does is borrow short and lend long: Brad Delong has used this as a definition of a bank.

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They had made two "slightly unsophisticated" errors, he said, which were to "borrow short and lend long" and to lend "very, very large amounts of money to people who could not pay them back".

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On the consumer banking side, a more normal yield curve would benefit banks like Morgan Stanley due to a better lending environment as banks can borrow short-term rates and lend long-term.

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This is especially bad news for banks because a major source of profits for money-center banks is the ability to borrow money at short-term rates and lend at long-term rates.

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By their nature, banks borrow short (from depositors or the wholesale markets) and lend long.

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It drives short-term interest rates lower allowing banks to borrow low on the short-term end of the yield curve, and lend high on the long end.

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