The beginning of the financial crisis:
Loans were extended to borrowers who traditionally were not considered credit worthy.  The banks charged a higher interest rate to these sub-prime borrowers and created variable rate loans.  Since housing prices were rising, there were few defaults initially as homeowners thought they could refinance before their interest rates reset.  
 
How did these loans make it to Wall Street? 
Traditionally, banks used to lend money based on the deposits they had in the bank. But they found by selling these mortgages to other institutions they could free up more money to lend more and at the same time diversify their risk.  Financial institutions, under regulation, were limited from buying these sub-prime mortgages because of their riskiness, but investment bankers were able to pool these loans to diversify the risk and create a financial instrument often referred to as Mortgage Backed Securities (MBS) or Collateralized Debt Obligations (CDOs).  The investment bankers who created the MBSs and CDOs were able to get high credit ratings for this debt by instituting levels, or tranches, designating who would get paid first if the subprime borrowers defaulted.  They sold these instruments to financial institutions world-wide. 
 
The liquidity crisis:
Interest rates started to rise and foreclosures on sub-prime loans increased at a rapid pace.  Since these mortgage-backed securities had been repackaged and resold none of the financial institutions, who regularly extend short-term loans to each other to cover expenses, knew what each other's exposure were to these "toxic assets."  Thus institutions were wary of each other and short-term borrowing costs increased rapidly.  With lending costs skyrocketing, institutions had few other options than to sell the mortgage-backed securities to generate the cash they needed to keep their doors open.  The problem is that no one wanted them, putting major financial institutions in a serious situation.
 
Government intervention:
The $700 billion buyout plan that Congress did not pass allowed the Treasury to step in and purchase these troubled assets at a discount, hold on to them, and eventually sell them for a profit.  Other competing plans allow the government to provide insurance on the underlying value of the assets.  In either case, the goal of any plan that passes will be to restore confidence in financial institutions so that they can begin lending to each other again, and restore order in the market. Check out CNN.com for the latest on the bail out plan details
 
 
What does it mean for my business?
With or without the government bailout, small businesses have already felt the pinch of the credit crisis. Here are a few things you should be aware of as we enter this unprecedented economic period.  

• Tighter lending standards:  Banks are re-evaluating their risk profiles of their borrowers.  Many small businesses owners, who have their personal homes or real estate as collateral have seen credit lines reduced and credit cards cancelled.  Now is not the time to hoard cash, but be mindful not to depend so heavily on the credit lines for day-to-day operations because they might not be there tomorrow.  Above all, keep on top of your debts and ensure your loan repayments are on time, you do not want to jeopardize your credit rating.
• Re-evaluate your bank.  Many regional banks have stuck to their traditional lending practices and have faired very well during the credit crisis.  Columbia Bank, Valley National and Hudson City proudly tout their record of making good loans.  However some banks have taken on riskier loans and are struggling.  Here is an interesting article about how "square" lenders have weathered the mortgage meltdown.  (Click here for Harvard Business Publishing article)  
• Look at your bank deposits.   While bank failures historically have been very rare, the recent market conditions have put some institutions at risk.  While they won't say who for fear of panic, there are 117 banks on the Federal Deposit Insurance Corporation's (FDIC) watch list.  The FDIC will guarantee up to $100,000 of your deposits at an institution.  If your cumulative CDs, checking and savings balances stand in excess of this amount, consider moving the excess to another bank, to ensure your deposits are safe. Click here for more information on how the FDIC insurance works.
• Be prepared for a rough ride.  Even if the government bailout is passed by Congress, the economy is still on shaky ground.  Home prices continue to fall and jobless rates are climbing, which means less money overall to buy your product or service.  Keep costs in check as much as possible without sacrificing your presence in the market and keep a watchful eye on your cash position, especially receivables.  For other ideas of what this means and for additional useful links, check out this article from BusinessWeek.