Remember just 17 months ago when Fed Chief Ben Bernanke told us not to worry about housing?

The subprime mess is grave but largely contained, said Federal Reserve Chairman Ben Bernanke Thursday

Just one month before that Treasury Secretary Paulson said:
"I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained. All the signs I look at" show "the housing market is at or near the bottom."

The biggest laugher of all, was Bernanke's prediction two months later, when he said:
"Some estimates are in the order of between $50 billion and $100 billion of losses associated with subprime credit problems."

Those guys are such kidders.

It turned out that the estimate of $50-$100 Billion was a little bit optimistic. Yesterday the Bank of England guessed a slightly higher number.

The BoE said financial markets appeared to have priced in losses of $2.8 trillion from the credit crisis, equal to more than two years of U.S. corporate profits...

As for the "contained" thing, that didn't work out so well either. It seems that some countries that you don't think of as 3rd world are having problems in the credit markets.

Austria, one of Europe's stronger economies, cancelled a bond auction on Monday in the latest sign that European governments are facing increasing problems raising debt in the deepening credit crisis.
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Spain, another triple A rated country, and Belgium have cancelled bond offerings in the past month because of the turbulence, with investors demanding much higher interest rates than debt managers had bargained for.

If triple-A rated countries like Austria can't sell debt, then what about countries with slightly less than perfect credit ratings? How are they going to manage to finance critical things like buying food from other nations?
Where there is a will there is a way.

Thailand on Monday said it planned to barter rice for oil with Iran in the clearest example to date of how the triple financial, fuel and food crisis is reshaping global trade as countries struggle with high commodity prices and a lack of credit.

The United Nations’ Food and Agriculture Organisation said such government-to-government bartering – a system of trade not used for decades – was likely to become more common as the private sector was finding it hard to access credit for food imports.

“Government-to-government deals will increase in number,” said Concepción Calpe, a senior economist at the FAO in Rome. “The lack of credit for trade could lead also to a resurgence of barter deals between countries,” she added.
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Ben Savage, managing director at London-based rice brokers Jackson Son & Co, said the full effects of the credit crunch had not been felt as most of current food trade related to contracts signed before the crisis.

Imagine that. The world's financial system is so broken that we have returned to a pre-money civilization.
How's that for "contained"?

The credit crisis is now running through the world markets like a bull in a china shop.

Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.

“This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon.
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Europe has already had its first foretaste of what this may mean. Iceland’s demise has left them nursing likely losses of $74bn (£47bn). The Germans have lost $22bn.

Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.

Amazingly, Spanish banks alone have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn) to what was once the US backyard. Hence the growing doubts about the health of Spain’s financial system – already under stress from its own property crash – as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.

The guys who couldn't see this coming just a little over a year ago are now being asked to fix it. Not just America's economy, but the entire world economy.
What does that mean? Take a look at this.

Oct. 28 (Bloomberg) -- Korea Development Bank was approved by the Federal Reserve to sell as much as $830 million of commercial paper to the U.S. central bank.

Uh, exactly why is the Federal Reserve buying foreign commercial paper issued by a foreign bank controlled by a sovereign! When did the Federal Reserve become the central bank of other nations? Are the people of other nations going to fund the Federal Reserve? Or is the American taxpayer now being tasked to bail out other nations?

Finally, decades too late, the rest of the world is questioning the structure of the financial world. When a nation can't get enough credit to buy food to feed its people, or when a nation's central bank has to be subsidized by another nation's central bank, then the system is either dysfunctional or broken or both.
We are approaching the end of Bretton Woods II.

The Bretton Woods 2 system – where China and then the oil-exporters provided (subsidized) financing to the US to sustain their exports – will come close to ending, at least temporarily. If the US and Europe are not importing much, the rest of the world won’t be exporting much.

And rather than ending with a whimper, Bretton Woods 2 may end with a bang.

In some sense Bretton Woods 2 has been on life support for a while now. China’s recent export growth has depended far more on Europe than on the US. US demand for non-oil imports peaked in 2006. One irony of the past year is that the US was borrowing far more from China that it was buying from China. Campaign rhetoric that the US was paying for Saudi oil with funds borrowed from China isn’t far off – though it leaves out the fact that the US also borrows from Saudi Arabia to pay for Venezuelan, Mexican and Nigerian oil.
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In retrospect, Bretton Woods 2 depended on two things: ongoing flows from the emerging world’s governments to the US Treasury and Agency market, and the ongoing ability of the US financial system (broadly defined to include the dollar-based “shadow” financial system operating in London and other offshore centers) to transform these flows into loans to ever-more indebted US households. US investors** effectively sold their holdings of Treasuries and Agencies to the world’s central banks, and then redeployed their funds into private-label mortgage-backed securities.

Or, to put it more succinctly, Bretton Woods 2, as it evolved, hinged both on the willingness of foreign central banks to take the currency risk associated with lending to the US at low rates in dollars despite the United States large current account deficit AND the willingness of private financial intermediaries to take the credit risk associated with lending at low rates to highly-indebted US households.

The second leg of the chain collapsed before the first. And it collapse looks set to deliver a nasty shock to everyone – including the countries that supply the US with vendor financing.