A dystopic email comment from my very smart friend Jeff Norman of Alpha Centauri Capital Management here in San Diego:

Here's my prediction as to what will happen:

If you played by the sensible financial rules all your  life, saved money, invested most of it in mutual funds now find that the government has taxed you over a trillion dollars to bailout institutions of immense former wealth, whose top employees have prospered outrageously.

Now you may end of giving more of it to neighbors who bought houses they couldn't afford and mortgage companies that were contemptibly greedy.  You can also expect to be bailing out some lost cause state and local government or quasi-governmental agencies.

Finally, after the markets have been successively devastated by each new round of bailouts your residual portfolio will be subject to the ravages of a bout of inflation that makes the 70s look tame.

There will then be no bailout for you.

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(Adopting a saying from the Czechs)

You can spend one trillion, two trillion, three trillion or four, but you cannot stop winter from coming.

Staggering stuff going on tonight in Asian markets, with the Nikkei off 10.5%, taking it back to levels last seen when Ronald Reagan was in the White House. Equally interesting, in a macabre way, is how the Nikkei and Dow created (I'm kidding, sort of) the mother of all long-term convergence trades: the ratio between the two indices was once 14x, and it's now 1.0 -- the Nikkei and the Dow, in other words, are at roughly the same level.

To save anyone the inevitable effort, please don't write in to explain the many ways in which the two indices are different, from capitalization to how they are constructed. I know, I know.

News that Citadel Capital has had its worst year ever should be final confirmation, if needed, that the great hedge fund unwind is underway. If Citadel can't navigate the current year, then a good bet is that most current funds can't. After all, only two strategies were up in September -- short bias and macro -- and most strategies are down more than 30% for the year-to-date. The capital-weighted  performance is worse if you consider that some of the better performing strategies, like short bias, manage negligible capital.

So, should we be worried? happy? other? Well, you need to understand the unwind  to understand the non-stop selling of equities going on worldwide. It's partly about revaluation in the face of long and deep recession, but the selling is also about broken hedge funds being forced to sell whatever is liquid to respond to margin calls and redemptions, and equities are more liquid than anything else they own, so they get sold, as do commodity futures.

It should sound familiar. It's like what happened last summer during the quant-quake. Oodles of quant funds got smoked as heavy selling of their holdings presaged multiple hedge fund meltdowns, in particular two at Bear Stearns. Something similar is going on here under the surface, and it's much wider than Citadel. Some have called it a margin call to the system, and that metaphor feels right to me -- right down to the likelihood that it ends with the failure of a couple of hedge funds. While we'll have down days like today and yesterday, the selling won't be non-stop. It doesn't work that way.

Can it happen cleanly?  For many firms, of course, but too many levered funds are trying to go to cash at once, and it's partly because, trapped in illiquid positions, they are selling the same stocks. And, at its worst, we have funds trying to martingale their way out, doubling down wherever they can, hoping against hope that a sharp move will cut their losses before clients yank out all the capital anyway. These latter funds are ticking time bombs, like a skein of LTCM-lites, all roiling markets in their death throes.

Some quick links to items of interest:

• Defaults coming in Brazilian agriculture (EMII)
• The Subprime Panic (SSRN)
• Peer-to-peer lending hits a hurdle (NYTimes.com)
• American's largest asset managers (EMII)
• Highland funds totalling $1.5-bllion to shut (Bloomberg)
• Credit Suisse/Tremont Hedge Fund Index is sown in September, including short-bias funds (MarketWatch)

As a related side, while shorts struggled in September in part because of the on-again off again bans, if any dedicated short bias funds are not positive in October they should be liquidated immediately.

A few people have asked, so here is my (very) simple hedge fund outflow model. I think it is fairly conservative, but the assumptions are obviously key and open to wide disagreement.

In essence, I'm aging hedge fund inflows and saying that we will see a blended 40% (higher in later years, lower in earlier years) demand for redemptions from investors in the 2005-2008 period. I'm not worrying about pre-2005 assets under management, so we could see lower redemptions on new assets and more on the older stuff, taking us to the same place. I'm also positing that initial capital has shrunk by a blended 20% on inflows, which is admittedly on the high side. I then figure that turns into almost $200-billion in outflows, or a little less than $2-trillion in asset sales at an average of 10x leverage.

What does it all mean? Well, with TrimTabs saying that we had $43-billion in September outflows, and assuming managers expect at least a 50% higher figure in October, that means another $60-billion in selling. We are then about half-way through the unwinding -- assuming no major uber-levered fund failures.

Some say the leverage is lower, some higher. Some argue we will see lower/higher redemptions, or that median versus mean losses will be wildly different. Other say it's inherently a state change issue, where the paradox of delevering is that everyone doesn't get to shrink -- some firms just fail outright. Sure, fine, good -- but this is was what got me thinking about it.