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.