JOHN FENZEL

The Volatile Mix of Myopia and Wishful Thinking...

"We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system"

-Ben Bernanke, Federal Reserve Chairman, May 17, 2007, a global credit crunch began three months later

About that Soft Landing....

"The steady improvement in [home] sales will support price appreciation...[despite]...all the wild projections by academics, Wall Street analysts, and others in the media."

-David Lereah, chief economist, National Association of Realtors, January 10, 2007. Housing prices steadily worsened, falling even farther than many skeptics had predicted.

No Bailouts? Think Again...

"So while some in Washington are proposing big interventions, most of the proposals I've seen would do more harm than good.... I'm not interested in bailing out investors, lenders, and speculators. I'm focused on solutions targeted at struggling homeowners who want to keep their homes."
-Treasury Secretary Henry Paulson, February 28, 2008

After all the bold talk about "No Bailouts" for investors or lenders, it turns out that is exactly what we are doing..and in all probability had been planning early on as soon as Bear Stearns had to be rescued from itself. Now, Indy Mac Bank has failed and U.S. taxpayers are bailing out both Freddie Mac and Fannie Mae. So, as David Ignatius so eloquently writes, you and I are, in fact, "Bailing Hard and Getting Soaked..."

 

By David Ignatius
Wednesday, July 16, 2008; A17

What are we taxpayers getting for our money as we bail out the geniuses who have run some of our leading financial institutions into the ground? The Treasury is extending a reported $300 billion line of credit to Fannie Mae and Freddie Mac, but what do we receive in return?

The answer, I'm afraid, is very little -- other than relief from the imminent threat of a much worse crisis. I'm glad that a systemic meltdown has been avoided again, temporarily. But these bailouts are the equivalent of "no document" loans to borrowers who are saying in effect, "Lend me billions right now or I'll destroy the international financial system."

I wish that Treasury and Federal Reserve officials would do a better job of bargaining -- so taxpayers wouldn't have to dig into their pockets again in a few months to rescue yet another group of spendthrift financiers. Perhaps Congress can ask some tough questions before approving the Fannie and Freddie package.

Another chapter of this slow-motion financial crackup is probably ahead. Eugene Ludwig, a former comptroller of the currency, says we're "perhaps only 30 percent to 40 percent through the trough."

Next up are the banks. All you have to do is look at the numbers: As of Monday, Wachovia's stock had fallen over the past year by 81 percent, Citigroup's by 71 percent and SunTrust's by 69 percent. And the stock of Washington Mutual, the nation's largest savings and loan, had tumbled 92 percent.

If these ailing banks should veer toward failure, do they get free access to the Fed's discount window, as Bear Stearns did? Do they get their debt guaranteed and the offer of a capital infusion, as Fannie and Freddie did? The disturbing answer is that bailouts will probably be reserved for institutions big enough to do damage if they fail but not for those so small that their collapse would be relatively quiet.

A new financial architecture is being built this year, but it's a jury-rigged structure with new wings added every time there's an imminent catastrophe. The financial disasters of the 1930s led to a regulatory framework that helped safeguard American prosperity for 50 years. This time around, we have a pell-mell fire brigade. Treasury and the Fed hose the financial markets with liquidity every time there's a new burst of flame, and, as a result, the system is beginning to get soggy.

So before this goes any further, let's think of some principles that should guide the government as it makes promises in taxpayers' names.

The starting point is that this corporate socialism (even the Wall Street Journal editorial page is calling it that) should promote fairness, transparency and market stability. Under the system that has been coming apart this year, employees and stockholders got the upside, while taxpayers got the downside. That's wrong.

Congress is already calling for more regulation, but, if it's not well planned, that could just make things worse. Fannie and Freddie had their own special regulator, the Office of Federal Housing Enterprise Oversight. It conducted lots of audits and studies over the past few years, but it couldn't stop many of the risky practices on Fannie's and Freddie's books. And when it did identify real problems, it was often rebuffed by Congress. The Sarbanes-Oxley reforms, enacted after the Enron scandal, created cumbersome paperwork but did nothing to check this crisis.

I like Ludwig's proposal for a new version of the Resolution Trust Corp. (RTC), which was created in 1989 to manage the savings and loan bailout. The RTC bought up distressed assets, creating a floor, and then resold them at prices that attracted new buyers -- so that the markets could clear. As Ludwig says, an RTC-like mechanism may be a better approach now than the ad hoc policy the Treasury and Fed have been following.

The best reform, in the end, is to make financial managers bear more of the risk of their actions. If a lender has to keep a big slice of the "B"-rated share of mortgages it has written, there's a greater likelihood it will lend only to borrowers who can repay. If capital and margin requirements are increased for lenders and borrowers, respectively, there's less chance of the crazy leveraging that has made this crisis so severe.

The lenders of last resort -- meaning the taxpayers -- have to get fair value for their money. As financial guru Warren Buffett likes to say, "Insanity consists of doing the same thing over and over again and expecting a different result."

WSJ.com - Crisis Deepens as Big Bank Fails

Bear Stearns was just the opening salvo, as Indy Mac's failure today demonstrates. Look for more dominoes to fall in the weeks and months ahead in what is shaping up to be the most serious financial and economic crisis our nation has seen since the Great Depression....

IndyMac Seized
In Largest Bust
In Two Decades

By DAMIAN PALETTA and DAVID ENRICH
July 12, 2008; Page A1

IndyMac Bank, a prolific mortgage specialist that helped fuel the housing boom, was seized Friday by federal regulators, in the third-largest bank failure in U.S. history.

IndyMac is the biggest mortgage lender to go under since a fall in housing prices and surge in defaults began rippling through the economy last year -- and it likely won't be the last. Banking regulators are bracing for a slew of failures over the next year as analysts say housing prices have yet to bottom out.

The collapse is expected to cost the Federal Deposit Insurance Corp. between $4 billion and $8 billion, potentially wiping out more than 10% of the FDIC's $53 billion deposit-insurance fund.

The Pasadena, Calif., thrift was one of the largest savings and loans in the country, with about $32 billion in assets. It now joins an infamous list of collapsed banks, topped by Continental Illinois National Bank & Trust Co., which failed in 1984 with $40 billion of assets. The second-largest failure was American Savings & Loan Association of Stockton, Calif., in 1988.

The director of the Office of Thrift Supervision, John Reich, blamed IndyMac's failure on comments made in late June by Sen. Charles Schumer (D., N.Y.), who sent a letter to the regulator raising concerns about the bank's solvency. In the following 11 days, spooked depositors withdrew a total of $1.3 billion. Mr. Reich said Sen. Schumer gave the bank a "heart attack."

"Would the institution have failed without the deposit run?" Mr. Reich asked reporters. "We'll never know the answer to that question."

Mr. Schumer quickly fired back.

"If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today," Sen. Schumer said. "Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs."

IndyMac had been troubled for months, and investors were concerned about its possible downfall well before Sen. Schumer's comments. It specialized in Alt-A loans, a type of mortgage that can often be offered to borrowers who don't fully document their incomes or assets. The company sold most of the loans it originated, but continued to hold some on its books. As defaults piled up, IndyMac's finances deteriorated.

The bank will be run by the FDIC and reopen Monday. The FDIC typically insures up to $100,000 per depositor. IndyMac had roughly $19 billion of deposits. Nearly $1 billion of those deposits were uninsured, affecting about 10,000 people, the FDIC said.

IndyMac's arc -- rapid growth, followed by an even more rapid descent -- is a microcosm of the mortgage industry. It boomed in the first part of this decade, as investors were willing to fund loans on ever-looser terms, then hit hard times when the housing market began to turn down in late 2006.

Small mortgage lenders started going under quickly, with the number of failures climbing into the hundreds. Now the fallout has spread world-wide, bringing down some of America's largest financial institutions. Bear Stearns Cos., which suffered losses on mortgage-related investments, underwent a meltdown in March and had to be rescued by J.P. Morgan Chase & Co.

Countrywide Financial Corp., at one time the nation's largest mortgage lender, saw its stock price plunge this year and was forced to sell itself to Bank of America Corp. at a firesale price.

IndyMac, in a last-ditch effort to fend off collapse after it failed to raise fresh capital, said this past week it was firing more than half its work force and closing most of its lending operations. While its shares had been tumbling since early 2007, the move was nonetheless jarring for a company that ranked as the ninth-largest U.S. mortgage lender last year in terms of loan volume, according to trade publication Inside Mortgage Finance.

IndyMac is one of the few federally insured banks to fail in recent years. Banking regulators are bulking up their staff of bank examiners and taking a tough approach toward banks that are seen as risky.

Mr. Reich, the thrift regulator, noted that the IndyMac case had some "unique" features, including the involvement of Sen. Schumer and the rapid fall in its deposits. Officials said most of the recent withdrawals came from depositors at branches, rather than those making deposits at IndyMac's online bank.

IndyMac was set up by Countrywide in 1985, but the two companies severed ties in 1997 and became direct competitors. The company's name stands for Independent National Mortgage. It was created to specialize in jumbo mortgages -- those that are too big to be sold to government-backed Fannie Mae and Freddie Mac. In 1997, under the direction of Chief Executive Michael Perry, a protege of Countrywide chief Angelo Mozilo, IndyMac set off on its own.

The company grew quickly, pioneering the issuance of so-called Alt-A mortgages to people with blemished credit histories. The loans have gained notoriety as an example of the type of lax lending that came to characterize much of the mortgage industry.

Early last year, Mr. Perry remained optimistic about IndyMac's future, insisting that the company had the resources to remain independent. At the time, IndyMac's stock was trading for about $45 a share.

But the combination of the frozen credit markets and mounting defaults on IndyMac loans steadily sapped investor confidence in the company. In February, IndyMac reported the first annual loss in its 23-year history. By this week, its shares, which ended last year at less than $7 each, were trading for 28 cents apiece.

The company was desperate for more capital but couldn't find investors willing to put fresh funds into what looked like a crippled institution.

The failure could be felt across the entire banking industry, as the FDIC will likely have to raise insurance assessments for all banks to build up government reserves. "It takes a big chunk out of the FDIC insurance fund," said Chip MacDonald, a banking lawyer at law firm Jones Day. He said that if the FDIC hikes insurance fees, that will add to already-intense pressure on bank profits.

The OTS and FDIC didn't secure any outside firm to acquire the bank's assets. The FDIC will temporarily run the bank through a new bank it has created, called IndyMac Federal Bank, FSB.

 

Mike Adams: The coming financial collapse of the U.S. government: Fed papers reveal what's in store for Americans

The bankruptcy of the United States government has been talked about for years by independent observers. If you've read the book, "Empire of Debt," then you know where the U.S. is headed financially. But most people have no idea about the ultimate financial consequences of decades of borrowing and spending by Washington, and they remain irrationally convinced that the status quo will remain intact for eternity. No one in any position of authority, you see, has yet admitted that the U.S. government is indeed going bankrupt. Until now, that is. In a remarkable paper posted by the Federal Reserve of St. Louis, and authored by a Boston University teacher named Prof Kotlikoff, it is revealed in blunt, powerful language that the era of borrowing and spending without consequence may soon come to a close. The paper, entitled, Is the United States Bankrupt?, may not remain posted for very long once the public gets word of what it actually says. And what, exactly, does it say? For starters, Kotlikoff explains, "Unless the United States moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion."

The country is bankrupt

He goes on to explain, "[that] the United States is going broke, [and] ...that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future." Failure to engage in these massive reforms will inevitably result in the financial demise of the United States, Kotlikoff says: "[W]e have a country at the end of its resources. It’s exhausted, stripped bear, destitute, bereft, wanting in property, and wrecked (at least in terms of its consumption and borrowing capacity) in consequence of failure to pay its creditors. In short, the country is bankrupt and is forced to reorganize its operations by paying its creditors (the oldsters) less than they were promised." We might possibly be saved, he explains, if the nation engages in massive, radical reform in three areas: 1) Eliminating the current income tax system and moving to a national retail sales tax of 33 percent. 2) Privatizing social security so that workers own their savings accounts and the federal government can no longer swipe funds from Social Security. 3) Launching a national health insurance program that covers everyone and relies on a system of government-issued vouchers that citizens can spend with health insurance companies.

These radical reforms are necessary because the future gap between what the government owes and what it stands to receive in revenues is already monstrously large, and it's growing by the minute. This gap, called the Gokhale and Smetters measure, currently stands at an astonishing $65.9 trillion. (Yes, with a "T".)

As Kotlikoff explains, "This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one’s head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole. The answers are terrifying. One solution is an immediate and permanent doubling of personal and corporate income taxes. Another is an immediate and permanent two-thirds cut in Social Security and Medicare benefits. A third alternative, were it feasible, would be to immediately and permanently cut all federal discretionary spending by 143 percent." If you read that last paragraph with any presence of mind, you now begin to understand the magnitude of the fiscal problem facing the United States. It could be solved, as explained above, by doubling all personal and corporate income taxes. But then what's the point in working? It could also be solved by slashing promised benefits in Social Security and Medicare. But what about the inevitable street riots? None of these solutions are likely to occur. And that leaves the Ace up the sleeve. It's the Ace that all government eventually play on their way to bankruptcy and collapse, and it's the Ace that the United States will ultimately be forced to play, too: hyperinflation. The U.S. will have to print more money to escape the financial consequences of its unbridled spending.

Hyperinflation is inevitable

As Kotlikoff explains: "Given the reluctance of our politicians to raise taxes, cut benefits, or even limit the growth in benefits, the most likely scenario is that the government will start printing money to pay its bills. This could arise in the context of the Federal Reserve “being forced” to buy Treasury bills and bonds to reduce interest rates. Specifically, once the financial markets begin to understand the depth and extent of the country’s financial insolvency, they will start worrying about inflation and about being paid back in watered-down dollars. This concern will lead them to start dumping their holdings of U.S. Treasuries. In so doing, they’ll drive up interest rates, which will lead the Fed to print money to buy up those bonds. The consequence will be more money creation—exactly what the bond traders will have come to fear. This could lead to spiraling expectations of higher inflation, with the process eventuating in hyperinflation." It's not like it hasn't happened before. Hyperinflation is actually the norm, not the exception, and it's the escape route taken by virtually every country suffering under the burden of payment promises is cannot possibly keep. Whether we're talking about Germany after World War I, or the United States over the next few years, hyperinflation is the only option remaining for politicians who refuse to practice fiscal sanity. No politician ever got elected by promising voters their entitlements would be halted, did they? Political popularity is derived from promising voters precisely what the nation cannot afford: Endless entitlements and runaway spending without apparent consequence.

The China factor

The only thing keeping the U.S. afloat right now is the temporary willingness of Asian countries to keep buying U.S. debt, thereby pumping up the U.S. economy with dollars earned on the backs of Chinese laborers. But even the Chinese -- known for their tolerance of hard times and manual labor -- may eventually tire of lending money to a posh, arrogant Western nation that has all but abandoned the concept of saving money. Says Kotlikoff, "China is saving so much that it’s running a current account surplus. Not only is China supplying capital to the rest of the world, it’s increasingly doing so via direct investment. The question for the United States is whether China will tire of investing only indirectly in our country and begin to sell its dollar-denominated reserves. Doing so could have spectacularly bad implications for the value of the dollar and the level of U.S. interest rates." By "spectacularly bad implications," Kotlikoff means the value of the U.S. dollar would plummet, the level of U.S. interest rates would skyrocket, and hyperinflation would be well underway. U.S. citizens would find not only their dollars to be near-worthless on the global market, but their savings to be all but wiped out as well. Sure, you'll still have the same number of dollars in your bank account, but they won't be worth anything. This is what eventually happens, by the way, when a government eliminates the gold standard and separates its currency from precious metals. The U.S. dollar, a green piece of paper, technically stands for nothing other than the U.S. government's promise to pay. But when push comes to shove, the government will have no choice but to hyperinflate its way out of financial obligations, thereby rendering all currently-held U.S. dollars to be virtually worthless. Those investors or citizens who hold savings in U.S. dollars will be wiped out by a government that will essentially steal their wealth without having to snatch a single physical dollar from their hands.

Future obligations cannot be met

And yet, despite the seriousness of the U.S. fiscal situation, Americans and their elected representative live their merry lives oblivious to financial reality. National newspaper headlines even add to the denial, running headlines that claim the nation's economy is strong because the 2006 budget deficit will be "only" $296 billion. That this is considered a success by the Bush Administration is testament to the psychotic fiscal self-deception that now serves as the norm in the United States. It's like a family that owes $1 million on a $200,000 home announcing "success" because it has just reduced its monthly credit card borrowing from $15,000 to $12,000. And that's if you actually believe the numbers, because if there's one area where Washington has proven its skill, it's the expert deployment of smoke and mirrors on all things involving numbers. Cutting the annual budget deficit won't save us anyway. It only means that we're barreling head-first into a brick wall at a slightly slower pace than before. The entitlements will still come due: "There are 77 million baby boomers now ranging from age 41 to age 59. All are hoping to collect tens of thousands of dollars in pension and healthcare benefits from the next generation. These claimants aren’t going away. In three years, the oldest boomers will be eligible for early Social Security benefits. In six years, the boomer vanguard will start collecting Medicare. Our nation has done nothing to prepare for this onslaught of obligation. Instead, it has continued to focus on a completely meaningless fiscal metric—“the” federal deficit—censored and studiously ignored long-term fiscal analyses that are scientifically coherent, and dramatically expanded the benefit levels being explicitly or implicitly promised to the baby boomers." The result of this is not in question: The United States government is already running on fumes, and in a few more years, it will suffer financial collapse. "Countries can and do go bankrupt," says Kotlikoff, and the U.S. is no exception to the laws of economic reality.

Oblivious to what's coming

The American people, as usual, remain oblivious to the financial future that awaits them. Even as the housing bubble is now beginning to burst in the nation's most overpriced real estate markets, most people don't have a clue what "hard times" really means. To today's debt-ridden yuppie spenders, "hard times" means shuffling six different credit card accounts to cover the payments on an overpriced house, two new SUVs in the driveway and a vacation to Paris, none of which the yuppie couple can afford. The idea of ever having to pay back their debt and live within their means is as foreign to most Americans as it is their own government. Financial consequences have been put off so habitually, for so long, that people forget they even exist. And thus the reality awakening becomes ever more rude when it finally appears. To say that most Americans will be in a state of shock when their life savings are suddenly wiped out is an understatement: These people will have never even imagined such an event is possible, much less contemplated how it might affect them.

Rome is burning

It's too late to save the United States from its financial meltdown, I believe. For starters, there is a complete lack of willingness to make tough financial decisions and begin paying off the national debt. Such an idea is so foreign to the U.S. that no presidential candidate in the last two decades has even seriously proposed such a plan, save perhaps Ross Perot, a man with such well-grounded ideas of cutting government spending that he was immediately branded a crackpot by the status quo. Even worse, there's not even recognition among the masses that a financial problem exists. As long as the President continues to proclaim the economy is in good shape, and the press remains complicit with its printing of economic half-truths, few will recognize any problem at all. Besides, any such recognition of the financial problems now facing this nation requires the observers to actually be able to do basic math. Our public education system, which is now largely considered institutionalized day care for nutritionally-deficient children, has seen to it that mathematics instruction never gets in the way of diagnosing children with Attention Deficit Hyperactivity Disorder and drugging them up on amphetamines so powerful that they actually have a street value as recreational drugs. Thus, few young Americans can even do math. And none of them lived through the Great Depression, nor did they understand the study of it in school, meaning they are precisely the kind of naive, overconfident yuppie spenders who are ripe for being financially obliterated by an economic meltdown. When their ignorance turns to fear, the ever-widening spiral of financial panic becomes unstoppable until the whole system hits rock bottom. And "rock bottom" is far, far below the relatively luxurious lifestyle to which American consumers have become so smugly accustomed.

Protecting yourself from the inevitable

The timetable for this economic collapse is unknown, but it's very unlikely to happen in the next year or two. A collapse by 2012 is certainly possible, and seeing it by 2020 is almost certain. That leaves the more intelligent among us plenty of time to prepare. But the usual preparatory actions by Americans won't suffice in such a large-scale collapse. FDIC-insured banks, for example, will almost certainly collapse and take the DFIC down with them. Even if you are repaid by the FDIC, you'll only be paid in worthless U.S. dollars anyway. Beating the odds on this financial hurricane requires exceptional planning and preparedness. I'll publish practical solutions and strategies on this website in the months and years ahead. If you'd like to stay informed, subscribe to the free NaturalNews email newsletter (see below) and make sure you select either "All topics" or the "CounterThink" topic. As a subscriber, you'll receive an email alert when I publish new solutions to the coming financial crisis that, according to many observers, now seems a foregone conclusion. Americans, it seems, are in for a rude awakening in the near future.

Elizabeth Warren :: The Collapse of the Middle Class

A thought provoking lecture from Elizabeth Warren (author of the book, The Two Income Trap) about the collapse of the middle class--an alarming trend that she sees in the United States. This will take some time to view, but save the post until you have the time to watch it in full. It's well worth the time....

Passing the Buck...

In a recent New York Times article, entitled "Where was the Wise Man?" former Treasury and current Chairman of the Executive Committee of Citigroup, Secretary Robert Rubin denies any responsibility for the enormous losses that have hit Citigroup in the wake of the sub-prime and credit crises:

“By the time I finished at Treasury, I decided I never wanted operating responsibility again,” Mr. Rubin, 69, said during a two-hour interview in his office. Sitting in a red-cloth chair and propped against a thick book to support a bad back, he made it plain that responsibility for Citigroup’s staggering losses can’t be laid at his feet.

“People know I was concerned about the markets,” he says. “Clearly, there were things wrong. But I don’t know of anyone who foresaw a perfect storm, and that’s what we’ve had here.”

“I don’t feel responsible, in light of the facts as I knew them in my role,” he adds.

But did he make mistakes?

“I’ve thought a lot about that,” he responds. “I honestly don’t know. In hindsight, there are a lot of things we’d do differently. But in the context of the facts as I knew them and my role, I’m inclined to think probably not.”

I've met Robert Rubin, spent time talking to him in his office, and walked away completely impressed with the man. In fact, they really don't come any better--he's decent, professional, experienced, kind, and brilliant. But in this case, he's dead wrong. When you are sitting in an office on the executive floor of Citigroup's headquarters in New York City, getting paid $15+ million a year, issuing denials rather than accepting one's share of responsibility for poor management decisions (and effectively blaming them on others)...well frankly, it just boggles the mind. As the "Wizard" of Citigroup, he absolutely shares responsibility for the disaster that has hit his organization.

Ultimately, that is the difference between leadership and management. Managers pass the buck. Leaders make the buck stop where they sit. Reading Rubin's statements, I was surprised. More than anything, I was saddened. Rubin is better than that.

And then yesterday, anticipating statistics that would confirm an anemic economy, President Bush also pushed the blame for the nation's economic woes elsewhere, blaming Congress for "letting the American people down." No admission of responsibility there either....

WSJ: One Guy Who Has Seen It All Doesn't Like What He Sees Now

One of Peter Bernstein's worries: 'If China goes into a recession, God knows.'

This Wall Street Journal interview with Peter Bernstein places our current economic situation in context. This, in conjunction with Warren Buffett's statement that the U.S. "recession will be longer and deeper than most people think...this will not be short and shallow," point to a long and difficult road ahead for the American economy. Bernstein's point that our recession could be further worsened by a Chinese recession points to the extreme degree of interdependence that did not exist for the United States in previous recessions. This could well be the perfect storm: as the United States enters its recession, as the sub-prime mortgage crisis continues to worsen, as gasoline prices approach $4 per gallon, food prices continue to escalate to record levels, and as consumer credit defaults escalate to unprecedented levels, and as an aging baby boom generation enters the Social Security rolls (not to mention Medicaid/Medicare), we find ourselves particularly vulnerable to what happens overseas, well-beyond our control. How did it happen? How bad will the recession be? How long will it take to correct? See Peter Bernstein's WSJ interview below, to find out....

One Guy Who Has Seen It All Doesn't Like What He Sees Now
By E.S. BROWNING
April 26, 2008; Page B1

Peter Bernstein has witnessed just about every financial crisis of the past century.

As a boy, he watched his father, a money manager, navigate the Depression. As a financial manager, consultant and financial historian, he personally dealt with the recession of 1958, the bear markets of the 1970s, the 1987 crash, the savings-and-loan crisis of the late 1980s and the 2000-2002 bear market that followed the tech-stock bubble.

Today's trouble, the 89-year-old Mr. Bernstein says, is worse than he has seen since the Depression and threatens to roil markets into 2009 and beyond -- longer than many people expect.

Mr. Bernstein, whose books include "Against the Gods: The Remarkable Story of Risk," sees two culprits. One is the abuse of securitization -- the trend for banks to hold fewer loans on their books and instead turn them into securities that were sold to other investors. The other is simply years of overborrowing by financial institutions and consumers alike.

Mr. Bernstein is hopeful that Federal Reserve intervention will prevent deflation and depression, but he says there is no guarantee.

Excerpts of a recent interview:

WSJ: Aside from securitization, what were the main causes of the problem?

Mr. Bernstein: You don't get into a mess without too much borrowing. It was sparked primarily by the hedge funds, which were both unregulated by government and in many ways unregulated by their owners, who gave their managers a very broad set of marching orders. It was a real delusion. It was like [former New York Gov. Eliot] Spitzer: "I am doing something dangerous, but because of who I am, and how smart I am, it is not going to come back to haunt me."

When you think about how all of this will work out in the long run, we are going to have an extremely risk-averse economy for a long time. The lesson has painfully been learned. That's part of the problem going forward. You don't have a high-growth exit from this, as you've had from other kinds of crises. We won't have a powerful start, where the business cycle looks like a V. Here, the shape of the business cycle is like an L, where it goes down and doesn't turn up. Or like a U, a flat U. The reason for that is that people aren't going to get caught in this bind again. They will tell themselves, "I'm too smart to do that again." And everyone else is going to be saying the same thing. It is, in fact, going to be a wonderful environment in which to take risk, because there aren't going to be any excesses.

I'm a child of the Depression, and I am thinking about what the early years were like after World War II. It took a very long time to get the memory of the Depression out of business decisions, and certainly banking decisions. I think this is going to be the same. The Fed, too, is going to be less decisive and is going to feel that what it should do is less clear. One of the things that gave people a sense that they could afford to take risks was the sense that the central bankers more or less know what they are doing. But I don't think we are going to feel that way going forward.

WSJ: You said that it could turn out that the smart thing to do is to take more risk, because everyone will be so risk-averse. What kinds of investments do you see as the big winners coming out of this?

Mr. Bernstein: You could say: the things that have been beaten down the most, which would be real estate. But I think real estate is going to be under a cloud for so long, and you can't buy real estate with cash, it is too much money. I think you should go with the stock market. If things are better, the stock market will go up, and if things are awful, the stock market is going to be way down. But it is a place where, if you want to take risks, you've got a wide range of choices. This is why I own stocks [in addition to other investments], because I don't know where the bottom is going to come, and I want to be exposed to every kind of possibility I can think of. And, at least, if you pick the stock market and you are wrong, you can change your mind. There is some liquidity there. Stocks never became cheap, but they didn't become crazy, the way other assets were.

WSJ: How long do you think this whole process will take, before we get back to normal?

Mr. Bernstein: Longer than people think. The people who think we will have turned in 2009 are wrong. There has to be a respite along the way. Nothing goes in one direction forever. But it will take longer than people think. If that weren't the case, I would be talking entirely differently. I would be saying, "What an opportunity we have got." And I just can't believe that the opportunity is here yet. There is too much to unwind.

WSJ: Can you explain the reason you think it will take a long time?

Mr. Bernstein: We have to go back to a moment when people have the courage to borrow and lenders have the courage to lend. Until credit is going up instead of down, you can't have growth. Housing has got to be a very important part of that; it always has been. You have to reach a point where somebody says, "This house is cheap, I am going to buy it," or where some businessman says, "This is a great opportunity for us to expand our business. Everything is available to us."

If China goes into a recession, God knows. The Iraq war and the whole situation with terrorism, we really don't know where that is going to come out. There are so many things that have got to get buttoned down before you say that the future looks good enough to take a risk.

WSJ: What kind of indications are you looking for as signs that the economy is about to get better and that the stock market and the investment world are about to turn the corner?

Mr. Bernstein: Somehow, the housing trouble has to at least flatten out. As long as that is going on, I think the pressure on the credit system is going to persist. It is kind of the leading indicator. It is where the trouble started. We have to underpin the consumer. That is why this is different. That is why this is like nothing we have had before.

Before, it was investment that made the V at the bottom of the business cycle. I don't see real investment turning enough without some sign from the consumer side. Maybe the foreign countries will do it for us. That is a substitute for consumption here. Maybe. But I think that they won't do enough for us, and maybe will be too infected by us to do it. But maybe growth in Asia will help us. The Asian thing is tremendously exciting.

Write to E.S. Browning at jim.browning@wsj.com

Kiplinger's Interview with Veteran Investor Bob Rodriguez

Here is an insightful excerpt from Kiplinger's interview with Bob Rodriguez (manager of FPA Capital (FPPTX) and FPA New Income (FPNIX)), , who saw America's sub-prime mortgage crisis coming well before others did, and took decisive action for his investors....

Were the Fed's actions appropriate?

I find what it did highly disturbing.

Why?

The Fed's actions were not vetted by Congress, and they put taxpayers' money at risk. I also predict we will see more pressure for a real estate bailout in the residential sector. Politicians will use the excuse that "we bailed out Wall Street, so why not Main Street?"

How do you assess the impact of the credit crunch on the economy?

Because of the credit contraction, any economic recovery will be subdued. I believe we are already in recession, and when the recovery comes, it will be substandard to the one that followed the 2001 recession. In the next five years, economic growth and productivity will be more subdued. The consumer is highly leveraged and this will hinder corporate profitability.

To read the entire interview, CLICK HERE.

The Economist: Postcards from the Ledge

These excerpts from a December article in The Economist, published well-before the fall of Bear Stearns, not only seem especially prescient today, they also shed excellent light on how the U.S banking crisis began and has continued to perpetuate itself:

November [2007] marked the stomach-churning moment when investors realised that the housing market was falling, that the losses would be big, that the banks would end up owning them, and that they had not put capital aside for the job. To make a bad case worse, nobody knows which bank is sitting on which liability. Every bank is suspect and any bank seeking to raise money by selling a position is more suspect than ever. As fear has played upon this lack of information, the money-market funds have gone on strike, cutting off the interbank markets' main source of cash, and the (embryonic) market for complex mortgage-backed derivatives has closed. It is an alarming mix of hiatus and distress.

If you put all that together, it is easy to see why an economy burdened by debt and a housing bust is in extra danger. Starved of funds and facing not just losses but lawsuits, the banks are hoarding liquidity and capital. That can create a vicious circle. As the system of leverage that magnifies credit collapses in on itself, borrowing becomes harder and demand falters. The rot can spread from housing to other areas, such as commercial property and credit card debt. If the money market funds then withdrew even more of their long-term lending from the banks, then banks will need to conserve yet more capital. And so it goes dismally on.