The financial crisis has been brutal and the sheer size of the fallout has been unexpected for many. Economic cycles are one thing, but the crisis of 2008 has seen the outright collapse or near collapse of household names in the US: Lehman Bros, Bear Sterns, Merrill Lynch, AIG, Freddie Mac, Fannie Mae, Citigroup, GM, Ford…the list goes on.

Over the past decade, companies and individuals became fat and lazy on credit and in 2008 the credit bubble finally burst. Now only the leanest and meanest companies on the block will survive and prosper.

The fallout is severe. Europe, Japan and the US have officially entered recession. Global growth has slowed and even China is paring back its growth forecasts.

Clearly, the highly paid finance nerds at the major banks worldwide didn’t see this one coming. Otherwise they would have sold off assets to reduce debt way before companies started hitting the wall.

Many investors, too, have been caught unawares as super funds and rainy day investment portfolios have slumped. The MSCI World Index has fallen by some 44%, and the ASX 200 index by around 42%.

In his book Collapse: How Societies Choose to Fail or Succeed, the writer Jared Diamond discusses the top reasons why societies fail:

1) They fail to anticipate problems.
2) They don’t respond promptly when problems arrive.
3) They exhibit something he calls “bad” rational behavior.
4) They adopt “disastrous values.”

The irrational lending practices that led to the sub-prime loan crisis was in essence the first domino that fell in this current crisis. The question is: are repeated Government bailouts of failing companies the correct response? And will the right action be taken swiftly enough?

Within just six months the landscape has changed drastically. Previous market darlings, such as BHP, are shelving expansion plans, blaming credit markets and falling global demand, while other companies across mining, financial and industrial sectors are struggling just to survive. Commodities prices including crude oil, copper, nickel have collapsed, causing miners to cut back production, lay off staff and shelve exploration projects.

Today, mining shares are down around 75% from their peak, gold shares some 68% and oil stocks 54%.

Back in February this year, in its highly publicised takeover bid for Rio Tinto, BHP made a formal offer of 3.4 shares for each Rio share. It valued Rio at over $140 billion at the time.

This week the takeover bid was scrapped and Rio’s shares hit a three-year low of $42, valuing Rio at just $54 billion (compare this to the value of Rio at its highs in May, at a monstrous $204 billion). It’s clear from this that management at neither Rio nor BHP had any inkling that a crisis of this magnitude was on the cards.

In a company statement announcing the decision to shelve plans to takeover Rio Tinto, Don Argus, BHP Billiton’s chairman, noted: “We have concerns about the continued deterioration of near term global economic conditions, the lack of any certainty as to the time it will take for conditions to improve and the risks that these issues imply for shareholder value.”

The following graph produced by Global Mining Investments shows the magnitude of the current crisis compared to past years. It represents yearly % price return of the HSBC Global Mining index over the past 20 years.

In 2008, the HSBC Global Mining Index has fallen some 50-60% – which is by far the worst performance in 20 years. In contrast, years 2003, 2005, 2006 and 2007 saw returns soar above 30%.

The crisis hasn’t been limited to the resources sector. The next graph provided by Global Mining Investments illustrates yearly returns on the S&P Index (in the US) over the past 183 years. From 1825 to 2008, the S&P Index had 129 positive years (or 70% of the time), and 54 negative years (30% of the time). But in just two years in history the index has suffered calamitous drops of between 40 and 50%. These two years were 1931, and, you guessed it – 2008.

So what will 2009 bring? With the seismic shift in the landscape – an all-pervading credit crisis, slowing demand from China and a rapidly deteriorating global economy – the future isn’t as bright for mining companies. However industry consolidation may well provide opportunities for the canny stock picker.