Three major U.S. banks – including Fifth Third Bancorp. (FITB) and Wachovia Corp. (WB) – got clobbered in recent days on the news that they’ve lost another $1.6 billion by making investments in the Citigroup Inc. (C) Falcon hedge fund that lost 75% of its value earlier this year.

It’s just the latest chapter in a continuing credit-crisis saga that’s gone on for so long that many investors have become numb to the news: They regard all new developments with a kind of "so what" attitude, or just ignore the news completely.

Believe me when I say that such a response is easy to understand. But hear me out as I underscore why investors must continue to watch this financial-services-sector saga closely. It’ll keep you out of trouble.

Let me explain …

The banks had invested the premiums from so-called "Bank Owned Life Insurance Vehicles," or BOLIs, which are designed to pay off when key employees die.

BOLIs, in case you are not familiar with them, are specialized policies typically purchased as an employee benefit. Banks use them to fund such expected costs as employee compensation and the accompanying benefits. Like most life-insurance-type policies, BOLI policies contain both an investment feature and a death benefit.

And that’s why banks like them.

Not only does the bank accrue investment earnings revenue because they own the policies (bank-owned is the "BO" component of "BOLI"), the financial institution also receives the death benefit.

And since neither the death benefit nor the increase in the value of the investment vehicle is taxed, BOLIs became the mother of all tax shelters for banks.

And that brings us to the core problem.

You see, by taking the investment portion of the life insurance policies and moving them from traditional portfolio choices into more risky hedge funds, a bank, or in some cases the insurance company that sold the bank the BOLI policy, could increase its investment return with an almost-instantaneous, performance-enhancing boost that looked good to regulators and shareholders alike.

Of course, if you’re a baseball fan – as well as an investor – you know very well that there’s a downside to "performance-enhancing" boosts, even though the dramatic performance gains make that dark side very tough to resist.

That’s clearly why Fifth Third, Wachovia and a still-unnamed regional bank risked a reported $1.6 billion of their respective BOLI programs, an anonymous source close to the matter told MarketWatch.com. Many banks, presumably including these three, use BOLIs to offset the costs of their employee benefit programs.

And they’re not the only ones….

BOLIs have proven to be so popular that banks – always looking for additional ways to "rev up returns," according to one news report – had more than $120 billion invested in them as of the end of last year.

But now the chickens are coming home to roost.

Fifth Third is suing Transamerica Life Insurance Co. – which sold it the policies – on the grounds that these investments in the Falcon fund were much more risky than the bank allegedly thought. Fifth Third also named Clark Consulting Corp. as a party in the lawsuit. Both Transamerica and Clark are subsidiaries of the Netherlands-based Aegon NV (ADR: AEG).

"As with many other credit-based investment products, the Falcon’s returns have been hurt by one of the most volatile periods for fixed income in recent memory,” said Citigroup spokeswoman Danielle Romero-Apsilos, Bloomberg News reported.

Filing a lawsuit is the Corporate America’s version of a high-school kid telling his teacher "the dog ate my homework."

It seems to me that if you weren’t so greedy in the first place – and had simply stuck to your knitting with prudent, risk-averse choices that didn’t require all this creative accounting – you wouldn’t have had a care in the world when Citi’s Falcon Fund lost three-quarters of its value.

The bottom line: There could be an entirely new wave of write-downs encroaching onto financial-services firms’ corporate earnings reports in the next few quarters to come. And, as was the case with the initial part of the subprime-mortgage debacle, some investors are likely to be very surprised at the identities of the early casualties.

But other investors will continue to say "so what?"

Investors who continue to follow these developments will do so with the understanding that this, too, shall pass – and some pretty profit plays will ultimately start to show themselves.

We’ll be there to tell you when that happens.

And it’s likely to begin well before you’d expect it.

After all, as the old Wall Street adage says: "Buy when there’s blood in the streets."

And if you’ve been listening to what we say, you’ll be able to say with confidence that none of that blood is yours.

News and Related Story Links:

• TheStreet.com:
  Citi Fund’s Woes Hit Wachovia, Fifth Third.

• The Australian [Business News]:
  Plunging Citi hedge fund hurts three big US banks.

• FINAlternatives:
  Citigroup Bails Out Troubled Falcon Hedge Funds.

• FindLaw.com:
  Bank-Owned Life Insurance Presents a Window of Opportunity.

• MassMutual Financial Group:
  Business Solutions; Executive Benefits: BOLI.

• Blog Site:
  Baseball’s Steroid Era.

• Wikipedia:
  Banned Substances in Baseball.

• Insurance Business Review:
  Aegon agrees to acquire Clark.

• Bloomberg News:
  Wachovia, Fifth Third Face Losses Tied to Hedge Funds