As the first wave of the credit crunch plays itself to a messy conclusion, we are almost certainly now into its second leg.

Collateralized debt obligations (CDOs) may have been the opening gambit, but credit default swaps (CDSs) are the new kids on the block.

George Soros estimates that the value of CDSs now equals half of the U.S.’s household wealth, an almost unimaginable number — let’s call it $23 trillion. So what are CDSs?

They are hedges made by investors in case a company defaults on its debts. In effect you bet on a company failing to protect your investment in the event it does just that.

The problem arises when large numbers of companies go bust and the CDSs themselves become worthless since no-one can pay them out.

A CDS seller undertakes to compensate a buyer if a corporate bond defaults. Since there is no limit to the size of cover taken out, the value of CDSs often exceeds a company’s debts.

Moreover, many CDSs are bought with borrowed money so the infection of the system drives deep into the financial heartland like veins in a blue cheese.

As defaults rise to unprecedented levels, so the whole ricketty system threatens to collapse.

Another nightmare to look forward to.

It’s official! Well, almost. The IMF, that august body which presumes to overlook the “world economy”, has used the “T” word.

The International Monetary Fund says that losses from the credit crunch by financial institutions worldwide are set to reach $1 trillion (£500 billion), threatening severe economic fallout.

The Fund says, “At present, the issuance of most structured credit products — instruments that pool and tranche credit risk exposures in various ways — is at a standstill and many banks are coping with losses and involuntary balance expansions.”

On the day when the UK’s biggest mortgage lender, the Halifax, reported a staggering 2.5pc drop in house prices in March alone, the IMF warns governments, central banks and regulators that they now face a test of their mettle unique in modern times.

In its twice-yearly Global Financial Stability Report, the Fund remarks, “The critical challenge now facing policymakers is to take immediate steps to mitigate the risks of an even more wrenching adjustment.”

The danger is that the escalating losses of banks, combined with credit market uncertainties, could generate a vicious downward spiral as they weaken economies and asset prices, leading to higher unemployment, more loan defaults and even deeper losses.

“This dynamic has the potential to be more severe than in previous credit cycles, given the degree of securitisation and leverage in the system.”

The report indicates that this downturn is about more than just liquidity, as some commentators are still arguing, but is rooted in “deep-seated fragilities” among banks with too little capital. This “means that its effects are likely to be broader, deeper and more protracted.”

In addition, “a broadening deterioration of credit is likely to put added pressure on systemically important financial institutions.”

Moreover, “The corporate debt market appears vulnerable as default rates are set to rise.” Loan defaults on junk bonds (high-risk corporate debt) have already begun to increase in both the US and Europe, which is “an area of specific concern”.

“This leaves financial institutions, most recently hedge funds, vulnerable to mutually reinforcing funding and market liquidity spirals, in which investors sell assets to meet funding requirements, creating price declines, a loss of confidence, and further funding pressures.”

The IMF advises : “National authorities may wish to prepare contingency plans for dealing with large stocks of impaired assets if writedowns lead to disruptive dynamics and significant negative effects on the real economy.”

Which broadly means that the situation is bad and getting worse, and the worst-case scenario may be just around the corner.

Macroeconomics was never so fascinating, and never so scary.

Read the report here.

This article is adapted from a piece which appeared in Syntagma in March.

It’s happening now in America and is due here in the UK and Europe by summer, if the usual time lags apply.

The recession / depression / crash is on its way like an unstoppable tsunami.

A tsunami is not a “tidal wave”. Waves break and retreat when they hit shallow waters or the shore. A tsunami trundles on for miles inshore powered by tremendous forces out in the deep ocean. No power on earth can stop it until its energy is spent.

Those who think we can stop a deep recession from happening by fiddling with interest rates or printing liquidity are looking at wave science not tsunamis. Now we can only watch and hope.

The signs of families cutting back their spending are everywhere here in Britain. Apart from the super-rich, ordinary folk are drawing in their horns as if they never existed. This mass retreat from the markets is beginning to have a cumulative effect which can only build to an inevitable crescendo.

The banks are barely functioning, except as deposit-takers. When they get our money they hoard it like the early Ebenezer Scrooge — the kind of man who creates depressions or shows us how to avoid them, depending on your point of view.

America is in deep trouble now, deserted even by the Sovereign Wealth Funds of the Orient, who just a few weeks ago seemed like saviours. Now they are pulling their cash out and retreating to the new economies of the East.

The “carry trade” to smaller Western economies, like Turkey, Iceland, Latvia, Estonia and others is falling apart, as will these countries in the coming months. Iceland may well be the first to crack, like some monstrous symptom of global warming tearing apart the ice sheets.

Those that are in the eurozone are being held together only by the common currency, the euro. But the fault-lines are beginning to show and it seems only a matter of time before the whole system snaps in a great twanging of over-stretched elastic. Beethoven would not recognize the new European Symphony about to be played. An Ode to Joy it isn’t.

If we look at all this from a Scroogian perspective though, it’s a kind of deep-cleanse that the world’s febrile financial sectors need — and this is certainly a problem of their making. This tsunami began in the boardrooms of banks and retail lenders, not in the real economy where most of us work — although our greed doubtless helped.

As America contracts, like a crab sensing danger, we can only await the storms to come. And they are the least of it. The unstoppable tsunami is the real enemy.