The recent story of the fallen Bear unfolded like a ballet, where every pas was beautiful and important, but still unpredictable for most people (me included).

I want to uncover few steps – where the real ballet master will probably see much more, but even a casual watcher is thrilled:

1. The first (minor) credit squeeze last August created a new interesting trade. A hedge fund can get long senior tranches (AAA rated) and short subordinate tranches (BBB), leverage this trade 30:1 and watch the money grow on the trees. This trade became incredibly popular

2. The short-term commercial paper market shrank about 30% in few months after August

3. Main street banks who lend to main street corporations have credit line obligations. Look at the H8 release to see the sharp acceleration of outstanding banking credit. The traditional credit growth more than compensated for the fallout of CP market. As I reported few weeks ago the outstanding credit line obligations are about $2.5 trillion

4. During the December debt squeeze banks ran out of funds to fulfill the credit line obligations and they were forced to sell assets (like stocks) and lend money to clients. Stock market fell on that

5. In December Feds created TAF to give banks further funds they need to lend out

6. During the next February-March credit crisis banks ran out of funds again. They still hold tons of senior tranches (AAA) of various securitized debt but unable to sell them because the market is frozen. So they were forced to sell municipal debts, which created major dislocations at that market. At the end banks have nothing else to sell

7. At March 11 Feds introduced the new TSLF $200 bln credit facility that allows banks to swap AAA-rated securitized debt for treasuries

8. That immediately unfroze the market for those securities, but prices fell. Why? Because all those prices were fictious, but the absence of mark-to-market valuation made the illusion that prices are better then they are. So formally the prices fell, even though in fact they improved, from zero to some new distressed value. Banks are selling all those securities while they still can. They don’t sell any BBB-rated stuff because that market remains frozen, so AAA prices are falling, BBB prices are “stable”

9. We still remember that there are many hedge funds that are long AAA, short BBB and leveraged 30:1. Those hedge funds are experiencing large paper losses and got margin calls

10. Besides that,  the unfreeze of the CDO markets created a big incentive for the creditors to issue margin calls and seize the assets while those assets are made temporarily liquid. The creditors don’t want to take chances. That was a direct unintended consequence of the Feds actions, though you may agree that this is very contra-intuitive

11. First was Thornburg, then Carlyle and then Bear

Keep watching Main Street banks credit line obligations. That’s where the current stage of the credit crunch is