Recession? Depression? How Deep, How Far and What Can Be Done?

As the financial crisis gains steam, moving from overextended American households to global banking giants, fear of a major crash is spreading. Talk of "Another Great Depression" has entered the mainstream discourse, 1 out of 6 homeowners are "under water" -- owing more to the banks than their houses are worth -- and $2 trillion of retirement wealth has evaporated over the course of a few short months. The markets have not been "calmed" by the government's heavy interventions; the Dow Jones Industrial Average touched a five-year low this week, and is now 40 percent below its peak of one year ago.

The question on most people's minds is just how far and deep the fallout from the crisis will go. Are we looking at the kind of recessions we've seen -- and survived -- in the early 1980s, early 1990s and at the beginning of this century, or are we staring into an abyss that will be far more painful, one that will profoundly transform our lifestyles?

There's no definitive answer. We're in uncharted waters, and anyone who says they know what will transpire in the next few years is selling snake oil. But some deep thinkers who have a solid command of the structures of the global economy can help us understand the best- and worst-case scenarios, the way the crisis is changing some of the economic establishment's most cherished and long-standing assumptions and what role government -- the American government and those overseas -- might play in minimizing the damage created by Wall Street's excesses.

I contacted a number of leading experts this week -- all highly respected in their field -- to get their reads on the possible impacts of the financial sector's meltdown, the likelihood of the recent bailout having the desired effect and where we might go from here.

There was quite a bit of consensus on several points. First, all agreed that we're in the early stages of a deep recession. Second, most believed that it was in no way inevitable that the crisis would develop into a full-blown 1930s-style depression, and some were skeptical that such an event is even possible in today's economy. Third, all agreed that the length and depth of the crisis would hinge on the actions taken by governments in the coming months. Finally, there was something approaching a consensus that the economic and political establishment has been deeply shaken by the events of recent months, and that the banking mess might lead to a very different approach to governing the "free market."

The Worst-Case Scenario

In a nutshell, the lack of transparency in the system -- the fact that nobody knows precisely who's holding what liabilities on their books -- has the potential to lead to a global loss of confidence among investors and institutions, and what would effectively be the modern-day equivalent of a bank run on the myriad institutions that hold (or guarantee) "toxic" debt-backed securities.

That prospect has already led to a near-freeze in the flow of loans that individuals and businesses require, and if the credit system doesn't shake loose it will make the economic contraction that's already begun longer and more severe and lead to further financial losses.

That might create a vicious cycle in the "real" economy, as jobs are lost, people lose their homes, local governments' revenues -- in the United States, based largely on property taxes -- are cut and their work forces slashed.

As Max Wolff, an economist at the New School, wrote me via e-mail, "we're dependent on our banks. Thus, their pain is ours. Millions will be fired. Retirements will be decimated. Opportunity will vanish, (and) consumption will fall. Everyone is already deeply influenced. This will become more obvious and more painfully evident with each passing day. When it rains on the top of the hill, those who live on the bottom of the hill drown." He added, "there's now a major flight from all risk assets" which will "cause massive pain and dislocation in the developing world." Wolff predicted that "large sections of the consumption economy" will vanish, which will "slam into the leading exporters' markets and undermine much of the recent surge in commodity prices."