Driving through Burger King Friday morning for their cini-minis and coffee, I couldn’t believe what I’d just heard on KNX – Bear Stearns had just collapsed. No way! Just 48 hours earlier, I’d read in the Wall Street Journal that their CEO emphatically claimed they were strong, liquid and able to withstand the credit crisis.

What happened? How could stock that sold for $150 a share just over a year ago be worth $2 today? Most of us with very busy lives only catch the headlines, sound bites and surface chatter of the financial mess we’re currently in, so this is a condensed version of why this is a “big deal”.

The bottom line is perception and trust – or a lack of it.

First, Bear Stearns. It was a classic run on a bank, but with a twist. It wasn’t we “little people” (remember the late Leona Helmsly – the “queen of mean” and how she referred to her staff?) wanting their money out. Bear Stearns acted as a banker (“prime broker”) for hedge funds and over a number of weeks big hedge funds started pulling their accounts and shifting them to other prime brokers.

The leak in the dam had begun. Once the rumors began, responsible managers couldn’t ignore them (think investor lawsuits), and thus the leak became a crescendo of a flood overnight. The perception became reality, because no bank can have everyone run for their cash at the same time.

Think about it. Five of us put $100 each into the Mom and Pop State Bank. That $500 is loaned out by the bank; they don’t HAVE our cash anymore. If all of us wanted our $100 back, it simply wouldn’t be there.

The secret to all this is liquidity. When I want my $100 back, someone else is (hopefully) putting $100 into their checking or savings account. Over the years, the “system” has been pretty well fine tuned to know how much liquidity MUST be kept in the system for it to function like a well oiled machine.

But it’s all based on perception and trust – I trust I can pull $100 out of my ATM. Companies trust their prime broker is liquid.

The arcane “repo” world (not autos, but repurchase) is where a lot of liquidity is raised for banks, hedge funds, and the like. They put up collateral (often bundled pools of mortgage backed securities), get short term cash (for just overnight, or a couple of days), then “repurchase” those securities. Roughly like a pawn shop. In normal times, these loans are cheap, fast and easy. They provide a powerful lubricant to the liquidity of our sophisticated financial market place.

But the market is constipated – completely plugged up. Nobody trusts anybody (see Wall Street Journal article “For World’s Bankers, Trust Becomes a Rare Commodity”).

“It was the market failure to roll repo…that appears to have been Bear’s problem” according to Jeffrey Rosenberg, Bank of America’s head of credit strategy research (quote from WSJ dated March 17).

So the Federal Reserve is trying to get the liquidity back into the market. A significant, controversial move was to allow the large broker houses to borrow (like banks) directly from the Fed. Controversial because they don’t have the level of fed supervision and oversight banks do.

But the Fed’s primary concern now is to start moving money around again – in a word: liquidity.