The bailouts have not halted financial institution failures, but have quickened the pace of failures.

As the stock market bubble was bursting in 2000 I suggested that readers keep notes or a journal, because someday they would be telling their grandchildren about the bursting of the tech bubble and its aftermath.

It’s only eight years later, and we have the potential for even more dramatic stories for our grandchildren than the 78% plunge of the Nasdaq in the 2000-2002 bear market.

If we believe one side, we might see the nation plunge into the next Great Depression.

What’s scary is they have some convincing evidence. There are too many economic conditions and reports that are accompanied by the observation that they are the worst numbers, or show the biggest decline, or are at the lowest levels, since the Great Depression.

If we believe the other side, the story will be of a great economic rescue, a dramatic pulling back of the economy from the brink of disaster. They say the U.S. economy remains basically healthy, the only problems being in housing and the financial sector, and those have pretty much reached bottom, and will reverse to the upside as soon as Washington comes through with “the final” rescue package.

I don’t believe either extreme view, of “over the cliff” or a sudden disappearance of all fears, will be what comes out of the wringer, but something in the middle; not the next Great Depression, but a serious recession; not 20% unemployment for many years as during the Great Depression, but probably 8% or 9% for a couple of years; not a 90% decline in the value of the Dow, as took place in the 1929-1932 market plunge, but a serious bear market.

In the July 28 issue of my newsletter I said, “The economic problems began with the bursting of the U.S. real estate bubble, and the recovery will not begin until the housing industry bottoms and begins to recover.”

Former Fed Chairman Alan Greenspan seems to agree. Two weeks ago, he said the U.S. economy is in “by far the worst situation I have ever seen,” that “it is still not resolved, has a ways to go, and will continue to be a corrosive force until the price of homes stabilizes” [italics are mine].

Unfortunately for that assessment, on Thursday it was reported that not only did new home sales decline a huge 11.5% in August (versus the consensus forecast of a 1% decline), but new home prices plunged 11.8%.

In the same interview, Greenspan was asked whether another major financial institution, “such as Washington Mutual (NYSE: WM, Stock Forum), AIG (NYSE: AIG, Stock Forum), or Merrill Lynch (NYSE: MER, Stock Forum),” would fail in the interim. He said, “I suspect we will see one fail.”

As we now know, all three failed, along with Lehman Bros., Fannie Mae (NYSE: FNM, Stock Forum), and Freddie Mac (NYSE: FRE, Stock Forum). So the worst situation he has ever seen has become even worse.

The Federal Reserve, the Treasury Department, and Congress have thrown a ton of money, loans, and government-backed guarantees at the situation over the last year. The total, not counting the $700 billion requested in the latest plan, is well over $1 trillion.

None have worked. The credit markets have not opened for borrowers, but have closed more tightly. The bailouts have not halted financial institution failures. In fact the pace of failures has quickened. Failures that were coming every couple of months, then every couple of weeks, now seem to hit every couple of days.

That’s pretty dire stuff, and it has the S&P 500 and Nasdaq down 23% from their October peaks – in official bear markets.

I have been saying all year that my work shows we are in a serious bear market that will probably last two or three years. That’s the bad news.

But I have also been saying I expect the market will see its low for the year in the October/November timeframe, and then launch into its biggest rally of the year. (The rally off the March low amounted to 13% for the S&P 500.)

I see nothing that takes me off that expectation.

October is only days away, and there is already enough fear and “blood in the streets” to indicate a bottom may be near. I’m not talking about the end of the bear market, but just the end of the decline that is taking place this year.

I expect the overall bear market will last for three years, similar to the 2000-2002 bear market, but like most bears, will have numerous opportunities for profits; by buying for the rallies, and short-selling and positioning in bear-type ETFs for the down-legs. Bear market rallies in the 2000-2002 bear amounted to as much as 30% for the Dow and 44% for the Nasdaq. And as with most buying opportunities, they began when corrections and surrounding conditions had created high levels of fear (such as the big six-month rally that began from the depths of despair just two weeks after the terrorist attacks in 2001).

Short-term, there is an old Wall Street adage, “Buy on the rumor, sell on the fact,” which says the market often rallies on the rumor of a coming positive event, and then runs into profit-taking when the rumor becomes fact.

So, it will be interesting to see the market’s response to the rescue effort that has been rumored for a couple of weeks now, and is expected to become fact today.

Sy Harding
Street Smart Report