There was an eerie feeling in financial markets around the world yesterday as investors and central banks alike sensed the momentum of the credit crisis had overtaken efforts to keep the damage under control.
When the US Government decided not to mount a rescue for one of its largest investment banks, Lehman Brothers, even the optimists started to worry about how bad it could get.
The lid is now off the financial crisis and where it goes from here is in the hands of the markets and the sentiment around it rather than central bank puppeteers.
Financial gurus such as the former US Federal Reserve chairman Alan Greenspan were claiming this crisis was the worst since the Great Depression. These comments, while alarmist, do reflect the gravity of the problem and at the same time affect the sentiment that will dictate how bad it really does get. If the US central bank can't bail out non-deposit taking institutions then there is no natural limit. It's free market forces taking control.
Traders in Australia yesterday sold off most stocks, with the big falls in banking shares taking the lead. But for the most part punters stayed on the sidelines waiting to see what would emerge from the Lehman bankruptcy and the desperate attempts to save the big US insurer AIG.
There is a feeling out there that no one quite knows what to do.
It's impossible to quantify the losses in the US or in Australia because asset values are falling and a balance sheet that looks healthy one day can be heavily geared a week later and potentially insolvent a few months on as asset values drop.
Assets directly invested in the US housing loans or insurance products associated with collateralised debt are probably more easy to value or devalue.
This was the first leg.
But when the crisis spread, and debt became scarce and expensive, the financial crisis took on a new dimension because wider asset values also began to fall.
Some corporate loans that once looked well covered have now become marginal.
And this situation has now become exacerbated by the fact that major Western economies are on the brink of recession and the earnings potential of assets is diminishing.
To date, Australian companies have felt only limited direct effects of this crisis. The over-geared companies such as Babcock & Brown and Allco, whose business models relied on being highly leveraged, were in the front line and the Australian banks that supported them have sustained a worse-than-usual bad debt experience.
The Australian banks also had some small direct exposure to US housing but nothing that would undermine their balance sheets.
Their second round exposures to the likes of Lehman Brothers is pretty small. In terms of globalisation, our banks have remained pretty conservative or at least parochial.
The biggest problem for banks in Australia has been rising cost of borrowing on wholesale markets.
If we move into a recession then credit growth will slow and further crimp earnings from the major banks. But it's a long way from scary.
The risk to our economy stems from the the potential recession world-wide and the effect that it has on demand from China for our mineral commodities.
To date the China boom has protected us from economic adversity. But commodities prices have been weakening and even the chairman of BHP, Don Argus, yesterday warned that in the short term commodities markets would remain volatile.
Until a few months ago Australian mineral commodities had been weathering the elements well. But the certainty in the China growth story is waning.
Without the support of the Asian growth machine, Australia is as susceptible to recession as any other. We don't have the direct fallout from the housing crisis that is crippling the US - but without a minerals boom we equally don't have the antibiotic to cure the contagion.
