Ben Bernanke - Source: © Manuel Balce Ceneta AP

Why did just talking about an end to the Federal Reserve's program of buying $85 billion in Treasurys and mortgage-backed securities throw global markets into such chaos?

I don't think you need to invoke "feral hogs" or imagine conspiracies by the gnomes of wherever to explain the global sell-off. It's really quite simple.

Fed Chairman Ben Bernanke's May 22 answer to a question after his congressional testimony marked the end of the "Bernanke put." That put -- what the financial markets have seen as the guarantee that the Federal Reserve would support asset prices -- has been a key to this rally, which took the Standard & Poor's 500 Index ($INX) from 1,131 in September 2011 to 1,650 in May 2013.

Something, some guarantee from the world's central banks and, most importantly, the Fed, has replaced it. It's not like the Fed is about to abandon its support for the mortgage market, for example.

But right now, nobody knows what's in the fine print of that guarantee, how good the guarantee is or how long it runs.

"When in doubt, get out" will rule huge hunks of global financial markets until the MBAs who crunch the numbers at the world's big financial institutions feel they understand the new guarantee enough that they can plug it into their formulas.

How long will that take? More than the few days of this week's bounce -- especially because it's clear that the bankers at the Federal Reserve aren't certain themselves about the fine print on that guarantee.

I think it's likely to take most of the summer, at least, to work out a new consensus on the central bank guarantee that will replace the Bernanke put. And until that consensus is in place, I think we'll see levels of volatility high enough to keep markets on edge and turn minor disappointments, worries and bits of bad news into major moves to the downside.

image: Jim Jubak

Jim Jubak

Everything has tumbled

The key to understanding this drop is that pretty much everything has tumbled at the same time.

Since May 22, the day that Bernanke offhandedly reminded everyone that the Fed would have to turn off the cash faucet at some point, U.S. stocks, as measured by the S&P 500, were down by 5.8% as of the close on June 24.

The damage to stocks didn't stop at U.S. borders. Japan's Nikkei 225 Index was down 16.4% in that period, and China's Shanghai Composite Index fell 14.7%. Brazil's Bovespa declined by 16.4%.

And it wasn't limited to stocks. U.S. Treasurys, as measured by the Bloomberg U.S. Treasury Bond Index, fell 3.3% from the May 8 high to the close on June 24. (Bonds, in general, peaked slightly ahead of stocks.) U.S. corporate high-yield bonds, known affectionately as "junk bonds," were down 5.3% in the same period. Emerging-market corporate bonds fell 8.3%.

That speaks to a worldwide, all-asset-classes re-evaluation of risk.

Assumptions about risk govern all the formulas Wall Street uses to calculate the value of individual financial assets. A stock is worth what it is in Wall Street's calculations because Wall Street can assume a company's cost of capital, for example, and then plug that assumption into a valuation formula. A bond is worth what it is in Wall Street's calculations because Wall Street can assume a rate of inflation and the appreciation/depreciation of the bond's currency.

Assumptions about risk get more important as strategies get more complex. If you're laying off the risk of the Japanese yen in order to go long Japanese stocks, for example, you need to make assumptions about the "riskiness" of each asset class and about the relationship of the risks of these asset classes.

Wall Street's most successful thinkers remember that they've made these kinds of assumptions and they constantly check to see if the assumptions remain justified. When they no longer are, or when it's not certain that the assumptions still make sense, the smartest course is to sell -- and either figure out new assumptions from the sidelines or wait until the logic behind those assumptions is more convincing.

Let me use a current market puzzle as an example. The yield on AAA-rated general obligation municipal bonds has climbed to 4% from 3% a month ago. That means that a bond worth $1,000 a month ago is worth $750 today.

That's simply stunning. Here we have a 25% loss in the highest-rated, lowest-risk tax-exempt government bonds. Has there been a huge surge in default risk in the last month? Maybe in places like Illinois or Rhode Island, where state and local governments are in deep, deep trouble after promising to pay out more than the budget can afford for years and years. But those aren't the kind of bonds we're talking about here. Illinois isn't rated AAA.

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So what's going on?

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