Let us for the moment assume that the worst of the 2007 subprime mortgage crisis is behind us — admittedly, a risky proposition. What have we learned?

We have learned that liquidity is not a function of corporate profits, cash flows, central bank accommodation, or any of the other factors that we look to. Rather, it is a function of investors’ willingness to play ball.

The day that buyers refused to roll over Countrywide Financial’s (CFC 21) commercial paper was the day that speculation about the leading mortgage originator’s very survival came into question, notwithstanding its solid back-stop of bank lines and the fact that it owns a bank.

Nothing had changed in terms of its financial condition from one day to the next; it was knocked silly by a change in perception.

Countrywide’s problems came on the heels of other problems in the broader commercial paper market, which up until recently had exhibited about the same degree of volatility as Stonehenge. Standard & Poor’s announced on August 14 that it was taking a dimmer view of the extendible notes backed by residential mortgages of three commercial paper conduits. Suddenly, corporations that had customarily financed operations through periodic refunding in the commercial paper markets had to pause and assess whether that source of funds would still be available. The Federal Reserve reported that commercial paper outstanding at week’s end dropped by $91.1 billion, with the bulk of the decline in asset-backed securities.

Because of the scrutiny and downgrading of some mortgage-backed short-term securities, investors became extremely jittery about money-market funds. Peter Crane of Crane Data Services had the unusual duty of going on TV with the news that moneymarket funds are not high-risk. Imagine. In fact, after the press erroneously reported that Sentinel Management, a commodities fund that got into trouble, was a money-market firm, investors started to bail out of such accounts and into Treasuries.

The concern was exacerbated by actual problems showing up in what Morningstar calls short or “ultrashort-term bond funds.” These are funds that investors have come to treat as substitutes for money market instruments. Morningstar reports that though such funds are the lowest-risk bond funds available, they do have the option to wander down the credit curve, and some have. Consequently, several of these funds have been hit by subprime problems. As of Friday, an investment in SSgA Yield Plus (SSYPX) was off 6.19% versus the prior month and down 4.48% year to date. This contrasts with competitor Pacific Capital U.S. Govt. Short F/I A (PCUAX), which was up 1.18% for the month and 3.13% year-to-date. Such variability in short-term instruments is almost unheard of. In other words, we have also learned that not all money-market instruments, or substitutes, are the same.

Why are perceptions so volatile? We have learned that the more complex the instruments, the less conviction investors have about hitting the low bid. Bottom fishing is relatively easy to do when a sound company’s stock gets unreasonably trashed. It’s a lot more challenging when investors don’t actually trust the numbers, because the portfolio is full of instruments backed by other instruments and leveraged to the hilt. What’s it worth? Nobody knows until a trade is executed.

When the Financial Accounting Standards Board issued FAS 157 last September, it acknowledged, in effect, that in some instances issues would be valued according to the trading experience of similar securities, or according to a model. If there are no buyers for a particular type of instrument on a given day, the value of that security is, as a result, estimated (some would say invented). This reality showed up in the problems of the two Bear Stearns hedge funds that came under fire in June. Moody’s Investors Service reports that as funds scrambled to raise money by selling collateralized debt obligations and residential mortgage-backed securities, the “prices for certain of these securities dropped to as low as 50 to 60 cents on the dollar.” In other words, there was virtually no way to value these products.

We have also learned that the ratings agencies are not ahead of the curve, and do not act as an early warning system. Far from it, in fact.

Last Thursday, Moody’s added fuel to the fire by downgrading 691 securities backed by secondlien mortgage loans issued in 2006; many had until last week been given the firm’s top Aaa rating. This was not especially helpful — to investors or to the market. More will be said about this deficiency in the months to come.

We have learned — again — that almost all asset classes have some degree of correlation. The price of oil, gold, real estate, emerging market equities, and possibly even contemporary art will ultimately be shown to have moved together, if not in lockstep, because the list of participants trading in such arcane sectors is relatively short, and the same emotionalism guides them all. Also, when hedge funds attempt to reduce their leverage, they are forced to sell holdings that are not under pressure. Bingo, everything starts south.

We have also learned that the Federal Reserve chairman, Ben Bernanke, gets the big picture. As credit markets seized up, sound businesses and the prospect of continued growth have been seriously threatened. Although the European central banks were surprisingly a little quicker off the mark than our own, Mr. Bernanke did come through with an all-important assist on Friday. That he chose to lower the discount rate rather than the Fed funds rate was seemingly a sop to those waiting to accuse him of bailing out speculators (such as Treasury Secretary Paulson’s former colleagues at Goldman Sachs). A more charitable view is that the move was less likely to slam the dollar. That hundreds of pension funds and college endowments are invested with those same speculators could also have inspired the move.

Finally, we have learned that investors still fly to quality, and that U.S. Treasuries still qualify as quality. Thank heavens.

The question is, when will we have to learn these lessons all over again?

peek10021@aol.com