But now, he and his colleagues were taken aback by what they were hearing. His big investors were worried about the Pershing assets held by Goldman Sachs, the blue-chip investment bank whose stocks had come under siege.

Never mind that Goldman kept Pershing's assets in a segregated account, and that the money was safe. And never mind that Mr Ackman believed Goldman was the world's best-run investment bank and would come through the credit crisis unscathed.

Pershing investors still feared their money might be exposed. Mr Ackman advised Goldman executives to do something to restore confidence. And while he kept his assets at Goldman, he hurriedly set up accounts at three other institutions – just in case.

Pershing had more faith than most. Up and down Wall Street, hedge funds with billions of dollars at Goldman and Morgan Stanley, another storied investment bank, were frantically pulling money out and looking for safer havens.

Panic was spreading on two of the scariest days ever in financial markets, and the biggest investors were panicking the most. Nobody was sure how much damage it would cause before it ended.

This is what a credit crisis looks like. It is not like a stock market crisis, where the scary plunge of stocks is obvious to all. The credit crisis has played out in places most people can't see. It is banks refusing to lend to other banks – even though that is one of the most essential functions of the banking system. It is a loss of confidence in seemingly healthy institutions like Morgan Stanley and Goldman – both of which reported profits even as the pressure was mounting. It is panicked hedge funds pulling out cash. It is frightened investors protecting themselves by buying credit default swaps – a financial insurance policy against potential bankruptcy – at 30 times the normal price.

It was this 36-hour period two weeks ago – from the morning of September 17 to the afternoon of September 18 – that spooked policymakers by opening cracks in the worldwide financial system.

In their rush to do something – and do it fast – Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson concluded the time had come to use the "break-the-glass" rescue plan they had been developing.

But in their urgency, they bypassed a crucial step in Washington and fashioned their US$700 billion bailout without doing political spadework, which led to a resounding rejection in the House of Representatives.

That Thursday evening, however, time was of the essence. In a hastily convened meeting, the two men presented, in the starkest terms imaginable, the outline of the US$700 billion plan to congressional leaders. "If we don't do this," Dr Bernanke said, according to several participants, "we may not have an economy on Monday."

Wall Street executives and federal officials had known since the previous weekend that it was likely to be a difficult week. With the government refusing to offer the same financial guarantees that helped save Bear Stearns, Fannie Mae and Freddie Mac, efforts on Saturday to find a buyer for Lehman Brothers had failed.

Merrill Lynch, fearing it would be next, had agreed to be bought by Bank of America. American International Group was near collapse – it would be rescued on the Tuesday by a US$85 billion loan from the Fed.

With government policymakers appearing to careen from crisis to crisis, the Dow Jones industrial average plunged 504 points on Monday, September 15. Panic was in the air.

At those weekend meetings, Wall Street executives and federal officials talked about the possibility of contagion – that the Lehman bankruptcy might set off so much fear among investors that the market "would pivot to the next weakest firm in the herd", as one federal official put it.

That firm, everyone knew, was likely to be Morgan Stanley, whose stock had been dropping since the previous Monday. In the space of three hours on September 16, Morgan Stanley shares fell an additional 28 per cent, and the rising cost of its credit default swaps suggested investors were predicting bankruptcy.

To allay the panic, the firm decided to report its earnings a day early. Its profits were terrific – US$1.425 billion, just a 3 per cent decline from last year – and the thinking was that would give investors the night to absorb the good news.

But contagion was already spreading. The problem posed by the Lehman bankruptcy was not the losses suffered by hedge funds and other investors who traded stocks or bonds with the firms. The real problem was that a handful of hedge funds that used the firm's London office to handle their trades had billions of dollars in balances frozen in the bankruptcy.

As this news spread, every other hedge fund manager had to worry about whether the balances they had at other Wall Street firms might suffer a similar fate. And Morgan Stanley and Goldman Sachs were the two biggest firms left that served this back-office role. That is why Mr Ackman's investors were calling him. And that is what caused hedge funds to pull money out of Morgan Stanley and Goldman Sachs, hedge their exposure by buying credit default swaps that would cover losses if either firm couldn't pay money they owed – or do both.

Fear was driving everyone's actions.

There was another piece of bad news spooking investors – and government officials. On Tuesday, the Reserve Primary Fund, a US$64 billion institutional money market fund, and two smaller, related funds, revealed they had "broken the buck" and would pay investors no more than 97 cents on the dollar.

Money market funds serve a critical role in greasing the wheels of commerce. They use investors' money to make short-term loans, known as commercial paper, to big corporations like General Motors, IBM and Microsoft. Commercial paper is attractive to money market funds because it pays them a higher interest rate than, say, US Treasury bills, but is still considered safe.

A run on money funds could force fund managers to shy away from commercial paper. One reason given by the Reserve Primary Fund for breaking the buck was that it had bought Lehman commercial paper with a face value of US$785 million that was now worth little. If money market funds became fearful of buying commercial paper, that would make it far more difficult for companies to raise the cash needed to pay employees, for instance. At that point, it would not just be the credit markets that were frozen, but commerce itself.

Just as important, in the eyes of federal officials, was that money market funds had long been viewed by investors as akin to bank accounts. These funds held US$3.4 trillion in assets.

"Breaking the buck was the Rubicon," said a federal official. "This was the first time in the crisis that you could see stories talking about how it was affecting real people."

Since that Monday, big institutional investors – like pension funds and college endowments – had been pulling money out of money funds. On Tuesday, individual investors joined the stampede.

Stock investors – feeling better because of the government's AIG rescue plan – either did not comprehend or ignored the growing chaos in credit markets; the Dow rose 141.51 points on Tuesday. The respite was brief: Wednesday, September 17, was one of those dark, ugly market days that offers not even a glimmer of hope.

Fearing the worst, Alex Ehrlich, the global head of prime services at the Swiss bank UBS, arrived at work in New York at 5am and immediately started putting out fires. Because he ran the firm's prime brokerage unit, clients were calling to see whether their money was safe.

"We were being flooded with client requests to move positions, and the funding markets, which are critically important to prime brokers, were extremely volatile," he said.

Within seconds of the market opening, the Dow was down 160 points and would end the day down 449. Among the big losers was Morgan Stanley. Despite its move to disclose its strong earnings late on Tuesday, its stock continued to plummet.

And that was just what investors could see. Behind the scenes, the credit markets had almost completely frozen up. Banks were refusing to lend to other banks, and spreads on credit default swaps on financial stocks – the price of insuring against bankruptcy – veered into uncharted waters.

Moreover, the drain on money funds continued. By the end of business on Wednesday, institutional investors had withdrawn more than US$290 billion. In what experts call a "flight to safety", investors were dumping stocks and bonds and even money market funds and buying the safest investments in the world: Treasury bills. As a result, yields on short-term Treasury bills dropped close to zero. That was almost unheard of.

Mr Ehrlich of UBS was horrified by the plunge of Morgan Stanley's shares, given the firm's stellar earnings. "It felt like there was no ground beneath your feet," he said. "I didn't know where it was going to end."

Neither did Morgan Stanley's chief executive, John Mack. A week before, his firm's stock was trading in the mid-40s. On Wednesday, it fell from US$28.70 a share to US$21.75 – down by half in a week.

"There is no rational basis for the movements in our stock or credit default spreads," Mr Mack wrote in a company-wide memo on Wednesday. He lashed out at the people he felt were responsible for Morgan Stanley's woes: the short-sellers who profit by betting that a stock will fall.

Like most Wall Street firms, over the years, Morgan Stanley had handled transactions for short-sellers, despite complaints by other companies that short-sellers unfairly ganged up on their stock. Nevertheless, Mr Mack called Senator Charles Schumer and Christopher Cox, the chairman of the Securities and Exchange Commission (SEC), pressing them to ban short-selling.

He raged about what he viewed as a concerted effort to drive down the firm's stock. "He got emotional," says one source.

Even as stocks tanked, turmoil was worsening in money markets. On Wednesday evening, Paul Schott Stevens, the head of the Investment Company Institute, learned about a problem with another money fund. "This time, it was Putnam," recalled Mr Stevens, referring to the Boston-based mutual fund company Putnam Investments.

Out of the blue, it seemed, there was a run on the US$12.3 billion Putnam Prime Money Market Fund. Because of huge withdrawals, Putnam decided it had to shut the fund and distribute the cash to shareholders. Despite efforts to prevent it from taking the step, on Thursday Putnam shuttered the fund. It has since been sold to another company.

Dr Bernanke has spent his career studying financial crises. His first important work as an economist was a study of the events that led to the Great Depression. Along with several economists, he came up with a phrase, "the financial accelerator", which described how deteriorating market conditions could speed until they became unmanageable.

To an alarming degree, the credit crisis had played out precisely as his academic work predicted. But his research had also led Mr Bernanke to the view that "situations where crises have really spiralled out of control are where the central bank has been on the sideline", said Mark Gertler, a New York University economist.

Dr Bernanke had no intention of keeping the Fed on the sidelines. As the crisis deepened, it took more aggressive steps. It added liquidity to the system. It opened the discount window – the emergency lending facility that had been reserved for troubled banks – to investment banks.

It also agreed to absorb up to US$29 billion in Bear Stearns losses and made the US$85 billion loan to keep AIG afloat. Representative Barney Frank, who leads the House Financial Services Committee, asked Dr Bernanke if the Fed had US$85 billion to spare. "We have $800 billion," he replied, according to Mr Frank.

Since the Bear Stearns bailout, Treasury and Fed officials had been discussing a broad government intervention. Although there were several suggestions for a "bank holiday" – the temporary, nationwide closing of banks, something that had not been done since 1933 to stem panicky withdrawals – Mr Bernanke and Mr Paulson dismissed the idea, fearing it would do far more harm than good by scaring people needlessly. They concluded that the best systemic solution was to buy hard-to-sell mortgage-backed securities.

That evening, Dr Bernanke told Mr Paulson during a conference call: "You have to go to Congress. This is pervasive." Mr Paulson agreed.

By Thursday, the need for dramatic action had grown even more urgent.

In Asia, where the markets had already closed, stocks were down. To quell fears before the opening of European markets, the Fed and other central banks announced they would make US$180 billion available, in an effort to get banks to start lending to each other again.

But it was to little avail.

On Thursday morning, markets were still roiled. The crisis was not easing.

By 1pm, the Dow had fallen another 150 points – taking it down nearly 600 points in 1-1/2 days. Goldman's stock – US$250 a share last October – dropped to US$85.88, its lowest in nearly six years.

Just then, a prankster piped The Star Spangled Banner over the firm's loudspeaker system on the 50th floor. Fixed-income traders stopped and stood to attention. Oddly, it was at precisely that moment that the market – and Goldman's shares – started to rise.

The traders began to cheer.

What happened? At 1pm, Britain's Financial Services Authority, which regulates its financial institutions, announced a 30-day ban on short-selling of 29 financial stocks.

"When I saw that, I knew we were about to have the mother of all short squeezes," said one hedge fund manager. Realising the SEC was likely to follow suit, hedge funds began "covering their shorts" – that is, buying the stocks they had borrowed to short, even if it meant taking a loss.

That caused all kinds of stocks to begin rising.

Sure enough, the SEC followed suit the next day – placing a temporary short-selling ban on 799 financial stocks.

A few hours later came the second event. At 3.01pm, CNBC reported the Treasury and the Fed were planning a giant fund to buy toxic mortgage-backed assets. In a 45-minute burst, the Dow gained another 300 points, closing up 410 points.

Two hours later, Mr Paulson and Dr Bernanke trooped up to Capitol Hill for a sombre session with congressional leaders. "That meeting was one of the most astounding experiences I've had in my 34 years in politics," said Senator Schumer.

As the congressmen and their aides listened, the two laid out their plan. They would begin offering federal insurance to money market funds immediately, in order to stop the run on money funds.

In addition, the SEC would institute a ban on short-selling of financial stocks. Although Treasury officials concede the move was mostly symbolic – investors can still buy put options that have the same effect as shorting stocks – they did it mainly "to scare the hell out of everybody", as one official put it.

It was then that Dr Bernanke made his remark about the possibility that there might not be an economy on Monday without this plan.

Congressional leaders were almost unanimous in saying it needed to be done for the good of the country. Congressman John Boehner of Ohio – the House Republican leader who, a week later, would lead the revolt against the plan – said it was time to put politics aside and move quickly, according to several participants.

After a week of wrangling, political in-fighting and compromise, the House on Monday voted down the legislation. The Dow plunged nearly 778 points, and credit markets worsened, with interest rates rising and loans becoming harder to get.

On Friday, two weeks after Mr Paulson and Dr Bernanke made their appeal, the House approved a US$700 billion bail-out.

Reuters