Poof! There go Americans' dreams

It will take days for owners of CDSs bought through Lehman to determine how much they have, much less to create a paper trail to present at bankruptcy court and to possibly find the counterparty to which they either owe money or by which they are owed. By some estimates, Lehman had 2 million CDS contracts outstanding.

Meanwhile, these trading operations are not doing anything productive to earn their companies money -- and the ones that were using CDSs as a hedge, rather than as a speculation, are frantically trying to find new counterparties with which to trade even though they don't know exactly how much money they have to work with. I'm told it's literally been chaos at big companies for three days, with people making mistakes and freaking out as they work 20 hours a day.

Raising cash -- and fear

Now, don't think anxiety has descended just in the back office. All day long, both regulators and stock analysts have been calling security dealers' chief executives to ask them about their liabilities, assets and collateral. When reports are published later in the week, you can bet that any reports listing companies with more liabilities than collateralized assets will lead to major equity and credit downgrades, and further serious stock losses.

When credit and equity are downgraded, contracts demand that companies come up with additional collateral to backstop their own liabilities. That means assets ranging from common stocks to U.S. Treasurys to equipment to asset-backed securities will flood the market over the next couple of weeks as companies speed to meet their obligations.

OK, now here's the place where you may need to cover your eyes.

Satyajit Das, a credit derivatives expert based in Australia, told me in a phone interview Monday from Singapore that these events have "essentially destroyed the capacity of the banking system to provide funding to businesses." He added: "Investment banks have destroyed their capital by making foolish loans on a massive scale, and the chance that they will get new capital, as they did back in the spring, is low. If you are a sovereign wealth fund and give new money to Wall Street now, you look like a chump. They won't be sugar daddies anymore. It won't fly politically at home. It isn't going to happen."

So who's going to refill the capital well? You may have heard that money does not grow on trees, and neither can countries actually "print" money, since that actually involves the sale of new bonds at a time when the market is flooded with them.

Well, U.S. Treasury and Federal Reserve officials have urged American banks to pool together a $70 billion fund to bail out weaker members of their tribe. But Das scoffed at the effort as a nonstarter, considering they are all equally desperate to hold on to their capital: "It's like the deaf . . . volunteering to help the blind," he said.

So you can see why stock markets are suffering. The credit engine that has fueled the planet's economic growth is now kaput, as banks and governments have downshifted from risk-taking mode into survival mode. The only hope now is that the unraveling will not accelerate and become an uncontrolled spiral into the ground.

"The European Central Bank and U.S. Federal Reserve have held international financing together with chicken wire and hope, and only now are people seeing how fragile it has been for years," Das said. "As the contraction of credit feeds out into the real economy, business expansion will grind to a halt, unemployment will soar, and consumer spending will falter -- all of which leads, in turn, to lower production and more unemployment."

2 games in 1

Almost a year ago to the day, as Bear Stearns' hedge funds were first unraveling and banks were about to start announcing billion-dollar write-downs, Das told me in this column that the credit crisis had not even reached the first inning and that the deleveraging process would be a prolonged event.

Now he thinks the financial part of the game is in the fifth inning, as it has raced toward the inevitable conclusion of large-company bankruptcies faster than he expected. There are only so many major institutions that can go under, after all, and already two are dead, and two more are on the brink.

Yet it turns out we're in a double-header, and the nightcap involving the crushing of the "real economy," which is where all of us live and work, is only in the first inning -- as companies are just starting to cut back jobs in a serious way to match diminished business and the loss of borrowing power. On Monday, Hewlett-Packard (HPQ, news, msgs) and Lehman Bros. announced plans to lay off 25,000 people each.

Now we just have to hope this game isn't called because of darkness.

At the time of publication, Jon Markman did not own or control shares of any company mentioned in this column.

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