A credit crunch is a bit like a bungee jump: the second one might be just as extreme, but the first one is always the scariest.

We're in a credit crunch right now: investors continue to skitter away from any kind of credit associated with mortgages, banks, or the wisdom of credit-rating agencies.

As a result, many financial markets remain unusually illiquid, inefficient, and bad at doing their primary job, which is allocating capital to where it can best be used. In that sense, very little has changed since the chaotic days of the credit crunch this summer.

But there's a big difference between now and then: no one is panicking. Celebrity fund manager Jim Cramer isn't disintegrating on live television; Federal Reserve chairman Ben Bernanke isn't cutting the discount rate by half a point in the wake of an unscheduled, emergency meeting of the Federal Open Market Committee.

Things might be bad now, but at least market professionals have a feeling that they know what the problems are, and how we got here.

"In some ways things are worse than they were during the summer," Deutsche Bank credit strategist John Tierney says. "The difference today is that people understand what the demon is. In the summertime there was a big black hole there."

So, with the benefit of hindsight, what did happen this summer? It certainly wasn't your grandfather's credit crisis (or that of your Argentine cousin), where a wave of defaults decimates the assets of the banking system.

Rather, the root of the problem was in the technology of securitization—and the fact that for decades now, U.S. investors have happily bought billions of dollars in mortgage-backed bonds without having to worry about whether borrowers pay them back as promised.

"Mortgage credit and the issue of default generally have been a backwater," says Tierney's colleague Karen Weaver, global head of securitization research at Deutsche Bank. "Most of the mortgage credit risk that was taken was taken by the G.S.E.'s."

The G.S.E.'s are government-sponsored enterprises like Fannie Mae, Freddie Mac, and Ginnie Mae: huge companies that buy up mortgages and then issue their own debt. Since Congress created these private companies, their debt carries an implicit government guarantee.

In other words, for almost all investors in mortgage-backed bonds, credit was simply never an issue. You would buy G.S.E. debt, and although you might not be sure when you'd be paid back (there was still a prepayment risk), you knew for sure that you'd be paid back, and that you'd be getting interest on your money until that day arrived.

There were some mortgages, however, that the G.S.E.'s wouldn't touch. Among them were subprime mortgages—loans to borrowers with weak or no credit. Those mortgages were bundled up by investment banks such as Bear Stearns and Lehman Brothers, and sold to investors sans any kind of credit guarantee at all.

Over the course of 2005 and 2006, especially, demand for such bonds was so strong that there was a huge incentive for the originators of subprime loans to write as many of them as they possibly could. Investors buying securities based on those mortgages generally had no idea how dangerous the underlying loans were.

They hadn't been worried about default rates in the past, even in the face of genuine disaster: After Hurricane Katrina devastated large swaths of Louisiana, Mississippi, and Alabama in the summer of 2005, mortgage pools that were concentrated in the affected states didn't noticeably underperform pools that weren't. And so investors didn't stop to worry about default rates when those rates started spiking upwards at the end of 2006.

Even mortgage-market bears such as Josh Rosner were saying as recently as March 2007 that mortgage investors should be worried about prepayment first and prepayment second.

Defaults might be bad for the long-term future of the asset class, the bears said, but wouldn't do much damage to any individual bond. After all, default rates were always going to be low compared to prepayment rates, and even an outright foreclosure is basically just a below-par prepayment, as far as an investor is concerned.

What's more, the first signs of trouble in the subprime market were early-payment defaults: borrowers taking out loans and, in many cases, never making any payments on those loans at all. Investors who bought those loans simply returned them to sender as being fraudulent—until those senders (the loan originators) closed their doors.

Even when that happened, however, the problem was considered to be a fraud issue, rather than a more systemic credit issue. People taking out recent-vintage "liar loans" might be defaulting, but subprime loans in general were not considered to be in great peril.

Then, in June, everything changed in a very scary way. And the cause of the chaos was not a mortgage originator at all: it was a hedge-fund manager by the name of Ralph Cioffi.

It's always a bit simplistic to point fingers, but if one man can be said to have triggered the credit crunch, Cioffi should be that man. Cioffi ran a pair of Bear Stearns hedge funds which had highly-leveraged exposure to subprime debt, and in mid-June those hedge funds went bust.

The impact of the Bear Stearns funds' collapse can hardly be overstated. Until that point, the financial sector had been largely insulated from problems in subprime: the only worries were that future securitization revenues were likely to fall.

Lenders had gone bust; investors had seen their bonds fall in value. But Wall Street, which had merely been the middleman between the two, seemed to be largely immune. Now, however, Bear Stearns—the leading mortgage house on Wall Street—was suddenly being caught unawares by defaults in the subprime market.

The Bear funds' implosion was enough to instill near-panic in the financial system. If something like this could happen to Bear Stearns, then it could—and probably would—happen to other Wall Street banks and hedge fund managers as well.

No one knew who was next, which meant that no one knew which banks were creditworthy—or whether any might actually be insolvent.

Banks had already been finding it increasingly difficult to sell their pipelines full of "covenant-lite" leveraged loans: risk appetite was drying up fast. But now anybody lending money in the interbank market had to worry not only about the corporate loans that might be stuck on a bank's balance sheet, but also about potential black holes that might exist off the balance sheet, in hedge funds, special investment vehicles, or elsewhere.

One day, banks were the lubricants of the financial system, abetting the free movement of abundant liquidity. The next day, they were clogging it up: no one wanted to entrust their money to them.

If Ralph Cioffi's funds hadn't failed, would the credit crunch have been avoided? No. The event that precipitated the crunch was unforeseeable. But the crunch itself was not, as Riccardo Rebonato, global head of market risk at Royal Bank of Scotland, explains:

"Many observers have been saying for a while that the conditions of extreme liquidity (too much money chasing too few investment opportunities) of the last few years created the perfect environment for a ‘bubble' to form and to pop. Risk managers around the world have known very well for quite some time that these conditions of loose money were a financial disaster waiting to happen.

"Guessing precisely which disaster would materialize is, however, no easier than predicting from which of the many cracks in a dam the water will eventually burst out."

Once the "mortgage" crack burst, other cracks were bound to burst as well. Confidence in the financial system disappeared, which sent interbank interest rates soaring. Investors saw AAA-rated bonds plunging in value, which meant that the faith they had placed in the credit-rating agencies had been misplaced.

On the other hand, there were potential weaknesses that held up relatively well: non-financial high-grade corporate bonds still look pretty good (corporate treasurers turn out to have been a lot more risk-averse than Wall Street's finest), and the broader stock market is set to end 2007 in positive territory.

The hedge funds that lost a lot of money in August were invariably "market-neutral," which meant that the broader market was largely unaffected when they were forced to unwind their positions at a loss. And, of course, the Fed has shown itself unafraid to step in and cut rates in an attempt to provide liquidity, even if doing so means a weaker dollar and higher inflation.

Next year, as in every year, there will market surprises. There's a good chance that the worst is not yet over: if 2007 was the year of turmoil in the financial markets, then 2008 might well be the year that the real economy buckles.

But at least the risk of a recession is a known risk, and markets are positioning themselves accordingly. The panicked days of July and August, when traders had no idea what was going on or where the next multibillion-dollar loss might come from, did finally come to an end.

A few months later, when Citigroup discovered an $11 billion black hole sitting in an off-balance-sheet structure, the fall in markets was a rational reaction to bad news, rather than a panicked rush to safety. Many traders even managed to make money from all the volatility.

The second time around, bungee jumping can be fun.