The Bailout -- how do we know we really have a problem?

As the politics of the bailout get more and more heated, my friend and colleague Frank Pasquale, a regular at this blogging stuff who has also been thinking about the proposed bailout, was kind enough to comment on one of my earlier posts.  In essence, he asks how do we know that the credit markets would really collapse if the bailout legislation did not pass?

It is not an easy question to answer, given that the markets are largely anticipating some sort of bailout -- albeit with some doubt thrown into the mix.

I look to three factors:

1.  The interbank LIBOR rate is acting erratically.  This is the rate that banks charge each other for loans.

2.   Non-financial corporations are stockpiling cash in case of a lending market shutdown.

3.  The CDS market (admittedly part of the problem here) is also acting erratically, moving sharply based on the latest news about the government's actions.  The following chart (produced by Markit) tells the story last week with regard to the movement of two leading CDS index measures: