Investors, bankers have lost their faith

— -- With its alphabet soup of CDO and CDS and TAF and TARP, the current financial crisis can seem hopelessly complex. But it really boils down to one word: confidence.

The global financial system is grinding its gears because, from big banks to small investors, the essential confidence required to buy, sell or invest has disappeared.

Except for cash-and-carry deals, every capitalist transaction requires a certain amount of faith: faith that an asset to be purchased has some genuine value, faith that a party borrowing money will survive to repay it. Right now, that basic element of trust is gone, and until it comes back, financial markets will remain skittish and economies around the world will suffer.

"You have a crisis of confidence because people don't believe the bankers, and the bankers don't believe each other," says David Smick, author of The World Is Curved: Hidden Dangers to the Global Economy.

What President Franklin Roosevelt in 1933 called "nameless, unreasoning, unjustified terror" now rules global markets. Fearing the future, investors are selling stocks they worry will be worth less tomorrow than they are today. Even the White House publicly mulling the government taking direct ownership stakes in several U.S. banks — something that would have been nearly unthinkable just a few weeks ago — did nothing Thursday to salve investors' frazzled nerves.

In the four weeks since investment bank Lehman Bros. declared bankruptcy, trust has drained from the system like water through a sieve. Rather than risk their capital by lending it to business borrowers, banks — many weakened by massive subprime mortgage losses — are hoarding cash.

"What we're scared about is not the bad news. It's rather the news that we haven't gotten yet. And human imagination is nothing if not limitless in its ability to create disastrous scenarios," said Andrew Lo, a finance professor at MIT's Sloan School of Management. "Right now, everybody's imagination is working overtime."