Sean-Paul Kelley visiting Thailand.

A friend who works in finance in NYC writes:

these are the scariest, most stressful times i have ever lived through: probably equal in magnitude to some past short spurts but the magnitude and the tape bombs are incredible. i worked the whole night lehman filed for bankruptcy. it is amazing how fast the names in the fin’l community have changed and how fast the shape of the fin’l system has changed. an era that started just before i got in the biz has ended… i am keeping my powder dry. have avoided a lot of the downside- i nver bot into 70% eqty. i was probably 30% last aug and have whittled down to about 10%, and seek the LOWEST yield in my cah- tsy only money mkt fund and tsy’s themselves. i did get knicked a bit in fannie pfd’s- only b/ i cant stand my voice broker at smith barney whom i threw a bone and gave a trade. the stuff i bot myself electronically, i sold at a profit. since i am only 10% in stocks and i have some short term losses, i am trading short term when i am not totally swamped doing my job, which is not often. i have done 3 trades, sent 2 bbrg’s and had 2 quick conversations in the span of `5 minutes it is taking me to write this… i feel like exam time back in school- exhausted, cramming for exams, just tryingto get to the finish line.

(A “bbrg” is a message sent through Bloomberg.)

A banker friend in London writes that the credit crunch has had a positive impact on his relationship with colleagues: “for the very first time in my career I didn’t get mad when the old grey guy on Credit Committee tried to reject my deal by pointing to the interest rate hedge and saying “and what if Treasuries go bankrupt?”

One week before the credit crunch really starts to bite, claims inched higher:

In the week ending Sept. 27, the advance figure for seasonally adjusted initial claims was 497,000, an increase of 1,000 from the previous week’s revised figure of 496,000. It is estimated that the effects of Hurricane Gustav in Louisiana and the effects of Hurricane Ike in Texas added approximately 45,000 claims to the total. The 4-week moving average was 474,000, an increase of 11,500 from the previous week’s unrevised average of 462,500.

Bloomberg reports:

This loss of liquidity has driven a wedge between bids and offers, allowing traders to collect higher fees, said Kumar Venkataraman, 35, an associate finance professor at Southern Methodist University’s Cox School of Business in Dallas. He wrote a study on bid-ask bond spreads in 2006.

The gap on about 1,000 investment-grade bonds averaged 32 basis points last week, excluding about 600 securities with spreads of 100 basis points or more, according to composite pricing data compiled by Bloomberg. That amounts to about $24 in commission per $1,000 bond.

The difference was about 7 basis points, or $5, for investment-grade bonds before regulators created Trace in 2002. The Financial Industry Regulatory Authority computer system disseminates prices to anyone with Internet access. The gap narrowed to about 4 basis points, or $3, immediately after, according to Venkataraman’s study, published in the Journal of Financial Economics. A basis point is 0.01 percentage point.

Let’s assume that the House of Representatives can get its head around passing the “banking system reinforcement act” aka The $700 billion Bonus Check to Wall Street Fatcats. (Are the odds of congressmen doing what’s right rather than trying to save their seats higher than 50%?)

If the act passes, maybe some liquidity starts to dribble through the system. Maybe banks start to lend to each other money at something other than a 500 basis point margin over the risk free rate.

But even with those improvements — and they also are uncertain — it will still be months before credit markets return to normal. It will be years before the housing market, which has accounted for up to 30% of GDP over the last decade, recovers. And it will be decades before we shrug off the memory of this debacle. And it may be a 100 years, if ever, before foreign buyers consider the greenback to be the reserve currency of choice.

The stock market crashes — ’87 and ’00 — we all use as benchmarks for the current debacle were superficial revaluations, games market participants were playing with each other. They may have scared people, but they didn’t touch the core of the economy. (The ’87 crash was a equity pricing re-adjustment after a 30% rise in rates, and the ’00 crash was a revaluation of overpriced Internet companies.) In contrast, this time around the stock market’s collapse is a trailing indicator of a fundamentally sick economy.

The cratering housing market is just one domino in a circular cascade. Yesterday we learned auto sales were off 26% in September. As factories and dealerships close, their workers dine out less, get fewer haircuts, pay fewer taxes. Municipalities pave fewer roads and lay off teachers’ aids. Fewer new homes will be built. Homeowners bail out of houses they would have never bought without reckless, eyes-shut lending. Newspapers close as ad spending declines. Consolidating banks lay off staff.

In short, there’s a lot of adjustment ahead.

Look for the market to step sideways some months, then tumble 10% lower some weeks. Over, up, over, DOWN, over, DOWN. Repeat. Some kind of sick dance-step.

The steps down will reflect the gradual process of cash holders trying to pick bottoms only to discover that the tide of bad news keeps flowing and they have to bail out, driving prices (and potential returns) to a new level of cheapness. Eventually, buyers and sellers will find the right price for all the cruddy news we’ll see emerging. Take a look at the stock market between 1929 and 1933… it took many exchanges of ownership and nearly four years to find the right valuation levels. (Great graph and prognostications here.)

The next news to watch is initial unemployment claims tomorrow at 8.30AM. God forbid it comes in at 600k AND Congress doesn’t pass the bailout.

But again, I think we’re in for a rough ride even if the House joins the Senate and passes the bailout. Though the ride may be slow and grinding and with occasional 4% upticks, it will be inexorably lower when looked at on a month to month basis.

(BTW, does anybody know what Harry Reid is talking about when he says a major insurance company is teetering on the edge of insolvency?) Today the Dow closed at 10,831 and Nasdaq closed at 2069.

Update: Joe Nocera gives a good recap of the (first) meltdown two weeks ago.

Watch CBS Videos Online

In the closing four minutes of trading today, Google dropped $70 on volume of 4.27 million shares to $341. Usually trades 50 to 100,000 shares in a 4 minute stretch. Either somebody knows something, somebody panicked or somebody mistakenly added an extra zero (or more) to a sell order. In after hours trading, Google is back up at $410. To put the swing in perspective, that’s a roughly $20 billion swing in Google’s valuation in 4 minutes.

Update: Clearly there’s zero liquidity in the markets right now. A big seller comes along and all the buyers hide. Who me? I’m not a market maker in the hottest tech company around. Maybe they’re going out of business and I don’t know something. Pity the poor guy who finally stepped up to buy the 4.27 million shares at a deep discount (approximately $280 million discount to be exact)… only to have the trade DKed the next day. (DK: Street lingo for “don’t know” or cancelled trade.)

I was premature in predicting panic Friday. Sadly, we got it today with the market down 7%. There’s likely more to come overnight… and maybe another 5 or 10% tomorrow?

The markets have fibrillated, and unfortunately, its now gonna take more than a $700 billion package to get things back on track. For the record, here’s Drudge’s headline package: