The Bear Trap

The general feeling in Washington seems to be that the Bear deal "threads the needle in the right way," as Democratic Senator Charles Schumer put it. But if Fed-arranged fire sales become a regular event, questions will inevitably arise about moral hazard and playing favorites. "They stepped into a vacuum, and I think quite appropriately," former Fed chairman Paul Volcker said on Charlie Rose. "But is this what you want for the long-standing regulatory support system? My answer is no."

Volcker and many other observers argue that if a mass-scale financial bailout is needed, it's the White House and Congress that must commit the resources. So far, the main movement in that direction is a proposal from Democrats Barney Frank in the House and Chris Dodd in the Senate to get the Federal Housing Administration to insure new loans for home owners facing foreclosure. But Congress could decide to take over and clean up every troubled financial institution in the land if things got bad enough. That would cost trillions, though, and still won't mean much if it's, say, a Swiss bank in big trouble.

There's also the question of revamping the inconsistent patchwork of regulations that enabled much of the madness in securitized mortgages. "It doesn't take long for the investment banks to find a nonregulatory place to fester in the dark," says Wall Street historian and Manhattan College finance professor Charles Geisst.

So Where Does That Leave You?

If you work on Wall Street or in real estate, you're already feeling the credit squeeze. The same is true if you have a reset mortgage you can no longer afford or if you just want to sell your house, especially if you live where prices are truly crashing, like San Diego or Miami.

For the rest of us, though, bad times are still just headlines. Most economists now think we're in a recession, but so far, it's a mild one, with unemployment at 4.8% and nonfinancial corporations still reporting strong profits. Stock prices are down, but not nearly as much as in 2001 and 2002.

Don't get too comfortable. "The best-case scenario is a mild recession and a slow recovery with mildly elevated inflation," says Harvard professor Kenneth Rogoff, a former chief economist at the International Monetary Fund. "That's the best outcome we can hope for at this point." Rogoff is a co-author, with the University of Maryland's Carmen Reinhart, of a much discussed new paper that surveys the five worst rich-country financial crises since World War II, and he finds alarming parallels to the current U.S. situation. Those crises all brought economic downturns that, while much milder than the Great Depression, were worse than anything the U.S. has experienced since. In other words, this could get ugly.

Fox appears on the miniseries Retirement Revolution airing on most PBS stations on March 31 and April 7. Check local listings.