Systemic collapse would have produced much greater change than what is currently proposed by calling into question the legitimacy of capitalism as an economic system, just as similar collapses have in the past.

On an economy wide basis, however, 5% reduction of economic activity would cause significant damage. A 40 or 50% reduction would cause societal turmoil. The abyss is utter collapse. It’s all relative, I suppose. But the magnitude of disruptions, and the seriousness of the situation, I fear is being discounted by too many people who have no connection to the problems and therefore are unable to imagine what is happening and what more can happen.

The causes are perhaps something that can and should have been addressed earlier, except everybody involved seems to have their lobbyists, and it appears that only crisis was enough to arouse Washington to an understanding of the consequences once it loomed.

A failure to regulate is among the causes… and specifically… a failure to regulate derivative contracts which like insurance policies assume liability in the event of some form of failure, but which unlike normally regulated insurance companies were not required to be backed by capital, and therefore could be stacked upon each other in mammoth leaning towers throughout the financial world. Failures (beginning with mortgage defaults) brought the whole interlocked structure down.

There is also the problem of principal/agent risk, that is, that the people that made the most money on these things fled the scene (legally) knowing that if ever the piper demanded to be paid, somebody else would have to do it.

It seems that the Treasury Department and the Fed have been as much the problem here as they are the solution. But clearly the financial institutions became invested in the specific solution as Paulson proposed. That is fishy in and of itself.

At the same time as all of this craziness has gone on, I have a good friend who obtained and closed on his first mortgage. I know of another company here in central Indiana who obtained a $600,000 or so loan to open up a new restaurant. Clearly the interbank movement of funds has been problematic, but money has not been as immovable as often reported.

The credit markets had stopped working almost completely in ways that perhaps mainly business people (that is, people who run genuine businesses, with payrolls and office expenses)were positioned to understand.

I’ll give two minor examples and one significant one.

Friday I made a deposit into my bank of the check that funds my business expenses for a full quarter, the account from which is drawn benefits including my payroll of two full-time employees, my health insurance payment (covering myself and my employees), the lease for our office space at Keystone Crossing, and the phone system, among other things. (I’m fortunate… my cash flow is fairly predictable both in income and in expense.)

Making the deposit in a major bank from an account from a similarly major financial institution, I was told this for the first time two Fridays ago in the midst of the crisis: You can have access to $100 today, 1/5 of your deposit in 5 days, and the remainder in 10 days.

In the meantime, I had a payroll to meet and an office expenses to pay.

Fortunately, understanding the nature of the crisis, I had prepositioned additional cash in that account a week earlier precisely because I wondered if such standard business practices could become endangered. Glad I did.

Other businesses in similar circumstances, perhaps vastly larger, I feel confident are presently even now having difficulty making payrolls, creating a cascading effect of employees not getting paid, landlords not getting paid, layoffs, etc., none of which would be otherwise be happening in a functioning (rather than momentarily broken) market economy.

As an another example, I know of a businessman who had a payment of $200,000 to make to another financial institution (Not in Indianapolis) two weeks ago. The entity would not accept a business check drawn on Wachovia, as had previously been the case.. then would not accept a CASHIER’s check drawn on Wachovia…. The businessman went personally to Wachovia with an armored car to obtain from his account $200,000 in CASH(!) to deliver to the other financial institution in the same town.

Finally, as another example… there is an international mechanism for the shipment of virtually all manufactured goods called a “Letter of Credit”, by which a bank in one locality guarantees the funds are secured and ready to be released to a bank another locality upon shipment of goods under specified terms for the benefit of the shipper.

If banks don’t trust that other banks will pay, they will not honor letters of credit, and goods will not ship internationally. I expect that this has already been happening in significant ways.

Our business communities are based on a fundamental trust (which is really just another word for credit) that people will get paid for the goods and services they render. In the absence of that trust, we would be each meeting in the middle of the road, you figuratively carrying a hen (for instance) and me carrying cash, if not a bundle of vegetables to trade.

If systemic collapse were to occur (as appeared likely without government intervention), trade of all manufactured goods would have quite possibly stopped overnight. Dominoes would quite possibly have fallen of company bankruptcies as they would have been unable to sell goods.

That’s why GM’s downgrade in the middle of the crisis was both logical and terrifying. The company and others like it could collapse overnight, unable to ship or obtain payment, throwing hundreds of thousands out of work… unable to pay mortgages and rents… unable to buy groceries…

While it would have been somewhat satisfying for those in the know to throw up their hands and allow everyone to learn the hard way, as one sometimes does to impress a lesson on those who don’t yet have the experience, in this case the devastation would have been intolerable. It is precisely those hard workers who don’t understand the peril and resent Wall Street (for good reason) who would be hurt the worst… thrown out of employment with no recourse.

I believe most understandably don’t have the exposure necessary to appreciate the consequences that would have fallen as the seven plagues upon us in systemic collapse. I believe most would have supported the measures had they been explained, but I think Paulson & Bernanke feared that the explanation itself would have aggravated the panic.