Illustration by Satoshi Kambayashi

IN MAY many investors took comfort in the view that the worst of the credit crisis may be over. But, as in 1939-40, says one hedge-fund manager, it was just “the phoney war. The tanks are about to roll into France.”

The gunners have certainly had plenty to aim at this week. Whether it was the downgrading of investment-bank debt, the purging of top brass at Wachovia and Washington Mutual, two large American banks, or the reconfigured rights issue at Bradford & Bingley, a troubled British mortgage lender, the news on both sides of the Atlantic has been grim.

Many hoped that the Bear Stearns bail-out in mid-March would prove the climactic event of the subprime crisis. After all, it seemed to imply that the Federal Reserve was standing behind the banks to prevent any systemic collapse. The cost of insuring banks against credit defaults fell sharply. But that trend reached its limit in mid-May and since then, according to one index, the price of insuring against default has risen by more than a third.

In any case, stockmarket movements suggest that bank shareholders were far less enthused by the Bear Stearns news. That is partly because investors fear the banks will have to follow Bradford & Bingley and Royal Bank of Scotland, a big British bank, and tap shareholders for additional capital.

Another sign of strain is the gap between money-market rates and official rates, which is still much wider than the historical average. Matt King, a strategist at Citigroup, says that this is not so much the banks' fear for the health of their competitors, as their reluctance to lend altogether.

Ever since last summer, the cost of funding for banks in the bond market has been higher than the cost of borrowing by non-financial companies. That makes bank lending unprofitable. In addition, the breakdown of the securitisation market makes it hard to get rid of loans. Worst of all, a forthcoming accounting change known as FAS 140 may force banks to take previous securitisations back onto their books; Mr King reckons some $5 trillion of assets will return to banks' balance sheets.

There has been, as yet, not much sign of a slowdown in lending. But that is because borrowers are taking advantage of the loan commitments made by banks during the boom years; some $6 trillion of these are still to be drawn down, double the level of five years ago. When it comes to new loans, the trend is clear. Surveys in both Europe and America show that banks are tightening their standards. In Britain the number of home mortgages taken out in April was just 58,000, down from 73,000 at the start of the year; in the euro zone bank lending to households is rising at its slowest rate since 2001.

The squeeze comes at an awkward time for consumers, hit as they have been by rising food and fuel prices and by (in America, at least) a softening labour market. Measures of consumer confidence have fallen sharply, although actual spending has not yet weakened to the same extent.

But consumer-default rates have started to climb sharply, as Bradford & Bingley's results revealed. And there will be write-offs on business loans as the year goes on. This bad news may already be reflected in the general level of corporate-debt spreads. But specific failures will still come as a nasty surprise to investors and institutions, and add to the malaise.

Of enduring concern are the monoline insurers, the institutions that agreed to guarantee some classes of debt against default. On June 4th Moody's, a rating agency, said it was thinking again about downgrading the AAA ratings of MBIA and Ambac, two of the main monolines. The pessimists (who are betting on a further fall in the price of the shares) reckon their losses on subprime-related debt will turn out to be many times bigger than the monolines' present capital.

If the theme of last year was turmoil in financial services, then 2008 could be the year when financial stress goes on to harm the economy. And it is not too fanciful to imagine a vicious circle: as the economic downturn causes more financial pain, so confidence will crumble further.

It seems far too early to say the financial world has seen “the beginning of the end” of the credit crunch. Indeed, the rest of Winston Churchill's quote about the progress of the war may even be too optimistic. The world may not even have seen “the end of the beginning”.