Unable to trust each other on credit-crunch Thursday, the banks all panicked and turned off the taps. The flow of interbank lending needed to keep the wheels of the global economy spinning dried to a trickle.

It was unprecedented. It was like a run on the banks – but by other banks.

The European Central Bank had to jump in with $180 billion to prevent a complete financial meltdown. Other central banks around the world followed suit.

Three months later, people are asking if anything happened. Some say there's nothing to worry about. But others are speculating that a landslide might have been triggered – one to match the worst economic collapses of any time in the past 100 years.

For now, the picture suggests that sharp interest-rates cuts in the United States appear to have staved off the threat of recession there.

The Bank of England rescued a building society that was going under. The stockmarkets did a wobble, but have since merrily bounced back.

In New Zealand, commentators such as Bank of New Zealand economist Tony Alexander and Chris Worthington, of Infometrics, are saying "relax, folks", the ship has been steadied.

"The global credit crunch, for all its sound and fury, signifies nothing particularly scary for the New Zealand economy," Worthington reassures.

BNZ's Alexander is similarly soothing: "For your average Kiwi, I don't believe this is going to manifest itself in any particular issues."

However, there are those such as Sydney derivatives expert Satyajit Das, a former investment-bank trader who reveals the industry's murky secrets in a recent book, Traders, Guns and Money. He fears we may well have suffered an almighty financial crash – we are talking 1987 or even 1929 here – and the news just has not managed to leak out yet.

Das says the credit crunch is the creature of the strange new world of credit trading, a largely off-balance-sheet and hidden business.

It is vaster than any stockmarket, but as yet has no visible indicators like a stockmarket index to chart its health.

So, he warns, on August 9, the golden era of laissez-faire economics, the "great moderation" or long boom which has lasted ever since the West conquered inflation in the 1980s, may well have ended. We could now be in for the long bust, the great hangover, as all the pent-up excesses of the past few decades – all the overpriced housing, ludicrous levels of personal debt, unsound retirement planning – are painfully unwound.

Right now, with the toxic waste in the system, there could be pension funds deep under water, household-name banking institutions on the brink.

And if it goes, Das says history teaches us that economic disruption always breeds social and political disruption. Past hard times saw the rise of socialism and fascism.

Others also fear the worst.

Darryl Queen is the managing director of Christchurch mortgage lenders PropertyFinance Securities which went into receivership in August when the credit crunch froze its funding. He believes the pain is only beginning.

New Zealand, being at the edges, may weather the storm better than many, Queen says. But he thinks there is a lot of financial poison to work its way through the system.

Neville Bennett, a retired University of Canterbury economic historian and financial columnist, says while it is possible some knight in shining armour might come along – the way a booming Japanese economy quickly pulled the world out of a hole after 1987's Black Monday sharemarket crash – he feels all the signs are that the good times are coming to an end.

Bennett himself sold shares and went into defensive mode in February at the first whispers of the credit problem emerging in the US's "subprime" mortgage market (mortgages advanced to the highest-risk borrowers).

So everything may be about to change. After the self-indulgent consumer boom, a time in which the Left and Right in the political spectrum became almost indistinguishable, a different world may lie before us. The credit crunch could be that significant.

"But at the moment, who can say," Das says.

The facts are still hidden from public gaze.

What justifies the apocalyptic talk among insiders?

To understand the fear, Das says you have to realise how much has changed inside the marble halls of high finance. Subprime mortgages are merely a symptom of a shift far more fundamental.

Putting it simply, Das says the first seismic shift is that credit – other people's debts – has become an asset which can be traded. The second is that trading in general has become wildly leveraged or geared. That is, most professional investing is now done with borrowed money or IOUs.

Das says in the good old days, people just bought and sold stocks and bonds. You took a punt on a particular company doing well.

Or you played safe and parked your cash in a bank deposit or government bond earning some set rate of interest, says Satyajit Das.

Most used money they actually had. But if you were a gambler, you might borrow money to buy a hot share – trade on margin.

Leveraging a deal like this multiplied your stake and so your potential profits, but also, of course, your potential losses.

In the '80s and '90s, the financial markets opened in several ways. Computer access democratised the markets so that anyone could join the professional dealers in their money games.

And the professionals kept inventing new asset classes. Stocks and bonds began to be overtaken by other vehicles such as currency speculation, commodity contracts and property funds.

There was also a shift from trading in tangibles to intangibles. A lot of the new stuff was about futures, options, arbitrage, derivatives – bets on events that might happen or trends that could pan out.

Das calls it candyfloss investing: a little bit of sugar spun into frothy confections consisting mainly of hot air. And every year, because the global money markets were frolicking in a benign era of tamed inflation, relatively low oil prices, and surging growth in China, India and the other new economies, the leverage, or gearing, was being cranked up another few notches.

"When I started trading 30 years ago, gearing was minimal – 1 to 2 or 1 to 3. It would routinely be 1 to 30 or 1 to 100 now," Das says.

Ratios of candy to floss that had once been daring became the norm. Das says everyone was doing it, even your staid high-street bank and pension provider.

And where there were banking rules designed to prevent such foolishness, there were always ways around the rules.

Then, in the early 2000s, the money markets discovered an entirely new game, one which could be the biggest and, perhaps now riskiest, game ever.

To outsiders, credit trading is just a blizzard of acronyms: structured-investment vehicles (SIVs), collateralised-debt obligations (CDOs), credit-default swaps (CDSs), mortgage-backed securities (MBSs), reverse-repurchase agreements (RRAs).

But its essentials are not so hard to understand.

It starts with a debt or loan. Someone lends money to someone else and gets promised a stream of interest payments for their trouble.

Again in the good old days, the person extending the credit hung on to the deal. A bank or building society owned a book of loans and was careful about being paid back.

But then some bright sparks pointed out there was this truly humungous pool of assets sitting around doing no work. In the financial world, moving money makes money. A little bit gets stuck to every hand it passes through.

So trading vehicles were created to unlock the world of credit.

Once the money markets had learnt to dice and shrinkwrap loans, credit became an asset that could be traded round the world. A French bank could buy US debt, or New Zealand debt for that matter.

This is the business that Christchurch's PropertyFinance had just started to get involved in – packaging local mortgages for general sale.

And once debt was being actively traded, gearing could now be applied to amplify the gains. A double whammy.

Das says few seem to appreciate what a significant shift this has been in the financial world. It was so new, vast and secret that even the regulators hardly knew what was going on under their noses.

And it has been happening right at the sober heart of the financial system.

In earlier economic bubbles like the dotcom mania of 2001 – the gravity-defying boom in fledgling internet companies – the banks and pension funds emerged largely unscathed because they did not dabble in start-up software-company shares. It was private investors who suffered mostly. But credit is a core activity which has now been drawn into the business of trading largely for the sake of trading.

The freeing-up of credit has been widely deemed a good thing. The global economy suddenly became a whole lot more liquid and supposedly more efficient. Like fertiliser, money could flow to wherever it would find a use, promoting faster growth.

However, this easy money has also had the unwanted effect of inflating asset prices. This has been obvious in house prices all around the world.

David Tillman, of Christchurch's David Tillman Mortgages, says it has been almost impossible to slow the "have it all now" generation.

He often finds himself advising clients to think again about signing over most of their income to a mortgage.

"We point out to people that the banks will lend you more money than you will be comfortable repaying. It is a trap. You get the house, you get the mortgage, but you also risk giving away your life," Tillman says.

Some draw back and start looking for a smaller house in a poorer suburb. Many more now think cheap money is the way of the world, here to stay, and are impatient to get on with the paperwork.

It has been the same with flash cars, big TVs and overseas holidays. The opening of the money taps at the top end has seen credit gushing into the crevices at every level of the consumer society.

Yet another example of the credit revolution has been the private-equity story, the new debt-backed wave of corporate raiders. Private-equity funds have been able to raise silly money to buy up any company not nailed down, driving up stockmarkets in the process.

Das says so many of the economic changes that have dominated business-page headlines over the past few years can be traced straight back to the credit-trading revolution.

It has become a huge financial bubble. How huge is difficult to fathom.

Das says in just a few years it has gone from nothing to trillions of dollars. And much of it is at the speculative frothy end.

The question now is has this credit bubble been messily punctured? And what sort of clean-up must follow?

Subprime mortgages have been the focus of events, but only as the pin that did the damage.

In February, it was revealed that a fifth of all new US mortgages were subprime – lent to people with no proven credit worthiness or job security, and often at teaser interest rates of just 1% or so for the first couple of years.

Canterbury University's Bennett says the minute he absorbed the implications of this, he knew it was time to move smartly into gold, government bonds and other defensive investments.

With US house prices slowing, the defaults had begun and funds were starting to take their hits.

It quickly became apparent that lending policies had been even laxer than realised. Once the personal link between lender and borrower had been broken, it was all too easy for unsound deals to be nodded through.

This created a ripple effect throughout the elaborate credit structures, one that threatened to throw the credit market into a death spiral that could have – no question about it says Das – taken the whole Western banking system with it.

US investment bank Bear Stearns was the first big name forced to reveal its hand when in June it admitted that two CDO funds worth over $4b had virtually evaporated. Massive gearing had produced massive losses. In August, other institutions started to come out of the woodwork.

On August 9, bad news about a French bank, BNP Paribas, was the final straw. The institutions lost their nerve and central bank regulators had to decide whether it was better to punish the foolish for their mistakes or prevent national economies going down the gurgler.

Officially, there was no crash, no violent jag on some stockmarket ticker to signal a reverse. And there were plenty of optimists ready to talk confidence back into the markets.

Keep spending. It was just a hiccup. A near thing perhaps, but also proof that in this modern era we can handle these sorts of speed wobbles.

But others like Bennett say the credit crunch means the wealth of US banks shrank by 20% this year. It may not be all on the balance sheet, but what more do you need to call it a market crash?

Das says the real picture may take months and even years to emerge. Certainly, first-quarter 2008 reports from financial institutions will make interesting reading.

Das's call is that the world economy may go sideways for five years to a decade. Because no-one will want to realise their truly staggering losses if they can help it, the central banks will quietly let inflation do the dirty work.

If inflation is allowed to run at 5% or 6% for a few years, then over-priced assets will have their value eroded to somewhere near where they should be.

So the bubble will be deflated with a prolonged hiss rather than a loud bang – and act as a brake on the global economy all the longer because of it.

But as yet, it has hardly started. Satyajit Das draws on a sporting metaphor to make the point bleakly: "Someone the other day asked me which innings I thought we were in. Was the credit crunch nearly all over? I said, `What? The national anthem hasn't finished playing yet'."

The Press | Saturday, 27 October 2007