Our market participants need to understand this today. This is Market Psychiatry 101. People will sell in panic and in a week or less will be overtaken with regret. Also, those who are trying to pick a bottom will be hurt. The point is that the markets are constructed in such a way as to separate the most money from the most people. They are constructed to inflict the most pain on the most people. Every successful trader and investor knows this. This is why so many fail (over 90% of new traders blow out their accounts in the first year!). This is, in large part due to their inability to understand the psychology of the markets which is no more than their own psychology.

Please review the Investor Sentiment Cycle that we have discussed so many times.

We are nearing levels 10 and 11 in the diagram below. The market is behaving like a crybaby who is now asking for a Fed rate cut ( despite the fact that it will do little to help this crisis since there already has been a stealth cut … but that is for another day).

We are heading into a full blown recession now and I cannot imagine that it will be "short and sweet" as the last two were. As Rome burned last week and Nero (aka Congress) fiddled away, Main Street got the picture and started a boycott, not out of spite or anger but out of fear. Parking places were suddenly easy to find on Main Street because the shops were empty. Talking to people who have their life savings invested in stocks, bonds and cash, one can palpably sense their fear. I cannot remember a situation like this in the forty years I have been in the investment business.

Even high school children are talking about the adversities that surround us. They are listening to their parents and they are hearing about jobs lost and savings wiped out and homes foreclosed and they are getting the picture.

The banking system, only so recently the willing source of more money than one should ever have needed or wanted, has suddenly and completely clammed up, cutting off funding and reneging on agreed upon lines of credit. Just listen to the stories of small business owners trying to finance inventories and homeowners counting on a line of credit to pay for their children’s college tuition. Just read the newspapers and listen to call in radio shows. It’s not just sad – it’s downright scary.

The passage of TARP last Friday was essential, but it is far from a panacea much less an instant solution. The loss of confidence that has gripped the banking industry will take a serious toll on businesses and consumers and those business and people are the economy. Unless the banks are willing to step up to the plate and make loans to healthy business and worthy individuals, they will only add to an already dreadful situation. Right now the banks are hording their cash because they have no confidence in the value of the assets backing their existing loans.

This problem is not just a US problem. The contagion has spread worldwide – Europe is no better off than the US and Russia’s capital system appears to have completely shut down. The spillover impact will hit India and China, whose economies will absorb the slowdown in demand from Europe and America.

How long this state of affairs will last is a function of how long it takes the world to deleverage. And deleveraging is a deflationary event. That is not good for economies, for profits, for the prices of assets and that includes the price of one’s home. The stock market does not work well in a deflationary environment. The only thing that looks good in deflation is cash. And right now cash is looking pretty good to me.

What other CNBC Contributors are Saying ...

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Patricia W. Chadwick has had more than 35 years of investment experience. She is the founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.

The take over of Fortis was complicated by the Dutchnationalizing their portion of the bank. This left Belgium andLuxembourg officials to take the remaining pieces and sell itto French bank BNP.

This is precisely why investors have become nervous over thecapabilities of European officials to deal with the creditcrunch in a coordinated, EU wide manner. Each action appears tobe country centric with no over-arching solution like in theUnited States. However, they do play follow-the-leader wellafter Ireland guaranteed all bank liabilities last week,Germany guaranteed all of its consumer bank deposits withSweden, Norway, Austria and Denmark engaging in similaractions.

However, the meeting over the weekend by European financeofficials did result in one major change. "The European Unionintends to make exchange rates a permanent part of the agendaof its regular summit meetings with other countries, theFinancial Times Deutschland reported Sunday.

• Money Markets Remain Frozen
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According to MNI, the paper cited an EU declaration entitled"A coordinated response to the economic downturn" that it saidEuropean finance ministers would ratify at their meeting onTuesday in Luxembourg. "The finance ministers are above alladdressing Europe's view that currencies like China's yuan areundervalued vis-a-vis the euro, the FTD reported." To me, thismeans Europe is now going to aggressively pursue a weakcurrency policy to help stimulate their economy.

With the turmoil in Europe, the change in the EU financeministers targeting the euro, and exiting of yen carry, the USdollar has become king. If it's even needed, this will provideadditional comfort for the Federal Reserve to remain aggressivein supplying liquidity to help ease the credit crunch.

These are dark times for the equity markets and the globaleconomy. The majority of new economic projections are negativeand are calling for prolonged recessions with growth notreturning until late 2009. The safe havens appear to be the USdollar and the Japanese yen.

• Global Markets Hammered As Recession FearsMount

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The Association of Financial Professionals (AFP) hasreleased a report detailing how finance executives have takendefensive measures to deal with the credit crunch. (AFP is amembership organization that serves more than 16k corporatetreasury and finance executives.)

From the AFP Short-Term Credit Access Survey, these actionsinclude reducing capital spending, freezing hiring, consideringlayoffs, and delaying payments to their suppliers. "Fortypercent of finance executives report that their organizationshave less access to short-term credit than they did one monthago, with 16 percent reporting significantly less or no accessto short-term credit. As a result, 62 percent of financeexecutives report that their organizations have already takendefensive actions. These organizations have:

• Moved all or most of short-term investments tobank deposits and U.S. Treasuries (41 percent);
• Reduced capital spending (37 percent);
• Shortened the duration of their investment portfolios(29 percent);
• Frozen or reduced hiring (26 percent);
• Drawn on existing credit facilities to build cash (26percent); and,
• Considered staff reductions or layoffs (22percent).

These actions could increase should the credit access notimprove by year end. Federal Reserve data shows that the U.S.commercial paper market contracted for the 3rd week in a rowand has dropped 11.5%. Along with other conduits of short-termborrowing, the commercial paper market is freezing up withcompanies and banks unable to access borrowing. I would cautionanyone who thinks that the credit crisis is only impacting themarginal borrowers or those with marginal credit. Clearly,these two reports illustrate the stressed nature of creditmarkets and a bleak future for the economy should credit notimprove.

This plan is just the start of government programs that willbe brought up and voted on in Congress until something works.If we go back to the Great Depression, FDR tried everythinglegal and not legal to get the gears of the economy movingagain. It re-wrote the rules for the economy and for governmentintervention.

In his proposals, FDR went far beyond what was permissibleby the constitution and the US Supreme Court struck many of hisproposals. It got was so contentious that FDR tried to changethe size of the court and pack it with his cronies. This is myassessment for the future especially if we have a Democraticpresident and a Democratic Congress. We should expect moreaggressive programs if we see no response shortly from theeconomy.

• September Payrolls Plunge; Jobless Rate Still at6.1%
• Jobs Outlook Darkens As Financial CrisisGrows

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Forget the pundits — look at what happened to the Intrade political futures market, tracing Sarah Palin withdrawal futures in real time, as Palin debated Joe Biden. They are now lower than Biden withdrawal futures.

For a third week, the total amount of commercial paper outstanding plunged, falling a record $94.9 billion in the week ended October 1st to $1.607 trillion, bringing the cumulative drop for the three weeks to $208 billion.

The declines reflect the seizing up of the credit market and withdrawals of monies from money market funds, which held $700 billion of commercial paper at the end of the second quarter. These declines in some ways carry more weight than those of a year ago, when the market was purging issuers with mortgage-related exposures.

This time the purge is broad and is impacting issuers with far more predictable cash flows--regular run-of-the-mill companies in need of working capital. For example, the asset-backed sector saw a $29.1 billion decline in the latest week, news that fits with the poor level of car sales, which are falling under the weight of the lack of availability of credit. The declines add to the urgency for fixes to the credit crisis and bolster the case for a Fed rate cut, which is sorely on many fronts. (Crescenzi discusses bond activity with James Bianco in the video).

Under the new "bailout" — "rescue" —legislation, Treasury will be purchasing billions of dollarsof mortgage-backed securities — mostly backed bysubprime mortgages.

Once Treasury has ownership of these securities, thegovernment becomes the owner of the mortgages and, like anyowner, responsible for administering the mortgage (i.e.collecting payments, maintaining the property, etc.).

The Senate has passed the Emergency Economic Stabilizationact with 74 to 25 vote. The mix was 40 Democrats and 34Republicans for the measure and 10 Democrats and 15 Republicansagainst it. (Ted Kennedy didn't vote.)

The EES was larded up with over $150 billion in pork barrelspending ranging from tax cuts for riding your bike to work toa 39 cent excise tax for children's wooden arrows. I'm notkidding.

From the portion of the bill addressing TARP: "PREVENTINGUNJUST ENRICHMENT.—In making purchases under theauthority of this Act, the Secretary will take such steps asmay be necessary to prevent unjust enrichment of financialinstitutions participating in a program established under thissection, including by preventing the sale of a troubled assetto the Secretary at a higher price than what the seller paid topurchase the asset.

This subsection does not apply to troubled assets acquiredin a merger or acquisition, or a purchase of as sets from afinancial institution in conservatorship or receivership, orthat has initiated bankruptcy proceedings 3 under title 11,United States Code." This should mean that anyone who has takenover a troubled US financial institution with MBS that has beenwritten down can sell those securities to the US Treasury at aprofit. I wonder how much this has come into play during therecent rash of takeovers or forced mergers has occurred?

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Now, the US House will be taking up the EES today andtomorrow. It's ironic that the larding up of the bill to getthe votes in the Senate is exactly why the bill may not passthe House. Blue Dog fiscally conservative Democrats don't likethe pork and wanted to maintain the pay-go structure for newspending. OnCNBC, former House of Representatives Republicanmajority leader Dick Armey has said that bill is an unnecessary$700 billion imposition on the tax payer. He's ripping intocurrent Republican Sen. Bob Corker who is the ranking member onthe Senate banking committee. It underscores the lack ofunderstanding of how the TARP plan works. Maybe there should bean education program prior to the vote in the House. Thisillustrates the divisions between the Republicans and betweenthe House and the Senate.

So where does this leave the House? I've heard Democratsstill want 100 Republican votes to ensure a "bi-partisan"agreement and cover to go back to their districts for theelection without having their opponents rip on them. It's thosecompetitive House races where the opposition to the billremains the strongest. There are aspects of this bill thatshould bring on Republicans such as the raising of the FDICinsurance coverage and the change in the mark-to-marketlanguage. There will be vigorous debate on this bill and thatmeans serious verbal shots over the next 24 hours predictingpassage and failure.

The only thing that matters is whether the bill isofficially announced to be brought up for a vote. Thatannouncement should be the all clear that the leaders have thevotes. No announcement of a vote on Friday will be a signalthat they don't have the votes. No vote means that the marketswill begin another round of equity selling and we'll start theprocess again on Monday.

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It came home to me loud and clear by mid-day yesterday why so many members of Congress simply could not vote in favor of the rescue bill before them now. The responses to my blog yesterday on CNBC.com “Why You Should Write Your Congressman ” were easily ten to one in opposition of my support of passage of the bill.

The language in some of the emails was simply unrepeatable and the vitriol and anger brought me back in time to my study of history. I had an image of Robespierre at the onset of the French Revolution with hordes of angry French citizens railing against the Crown.

I truly wished I could respond to many of the hate-mailers, but I realized it would have no impact on their point of view. Their anger was understandable and most of them cannot be blamed in any way for the crisis. However, their voices cannot justify allowing the entire financial system to collapse and as punishment for past mismanagement.

Unfortunately, despite dire warnings from sage and respected investors such as Warren Buffet and Bill Gross, Middle America is not convinced that the bill before Congress is not simply another bailout of the rich at the expense of the rest of the population. Nothing will disavow them of that. Hopefully enough members of the House and the Senate will have the fortitude and integrity to risk the possible political repercussions and vote to pass the bill before them. Sometimes the patient really does not know what is best for him or her.

I encourage people to go online and read Thomas L. Friedman’s op-ed article “Rescue the Rescue ” in the New York Times today. It is lucid and totally on the mark.

Battling the Credit Crunch

What other CNBC Contributors are Saying ...

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Patricia W. Chadwick is an asset manager and financial consultant with more than 25 years of investment experience. She is founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.

The process to produce the Treasury Asset Recovery Plan fromthe US House has moved forward in the Senate. They have wiselyremained it the Emergency Economic Stabilization Act of 2008,something I believe/suggested would help sell it to MainStreet.

Here's the laundry list: "(1) to immediately provideauthority and facilities that the Secretary of the Treasury canuse to restore liquidity and stability to the financial systemof the United States; and (2) to ensure that such authority andsuch facilities are used in a manner that—(A) protectshome values, college funds, retirement accounts, and lifesavings; (B) preserves homeownership and promotes jobs andeconomic growth; (C) maximizes overall returns to the taxpayersof the United States; and (D) provides public accountabilityfor the exercise of such authority."

This has a completely different vibe compared to the 2.5page grab-n-go bill that Paulson/Bernanke presented last week.Friend, neighbors, and countrymen, it's all about how youmarket it. This current form is what it should've been to getpassed in the first place.

Now the bill looks like bratwurst stuffed with a specialmystery meat to get broader approval from all walks of thepolitical taste spectrum. The current bill has expanded fromthe US House bill of 102 pages to a whopper of 451 pages. Now,paper mills are revving up for the final package. From taxbreak extenders ($149 billion over 10 years) to alternativeenergy to an increase in FDIC insurance for deposits up to 250kto authority to suspend mark-to-market accounting, this bill isgoing to pass the Senate when they vote on it tonight.

• GOP Members Forging Alternative Bailout Plan

I don't agree with it or like it, but this is how it works.What this glaringly points out is the lack of politicalforesight by Paulson/Bernanke in understanding how ourpolitical process works. Yes, the United States has a messy,ugly process.....but you can't ignore how it works to get whatyou want. Especially if you're asking for extra-ordinary powerand money. The crushing drop in the US stock market which wipedout more in dollar terms (over $1 trillion) than the cost ofthe bill did the best job of selling this to constituents. Aspredicted on Friday, voters opened their 401ks/pensionstatements and then called their Congressmen and Senators toexpress their new way of thinking about the bailout plan.

Last night on "Closing Bell" I said that if the US House ofRepresentatives brings this bill up again for a vote, it willpass. Why? There's no way Nancy Pelosi will bring up a billthat will fail because she will lose her job and so will manyDemocrats in the election. Congress has an extremely lowapproval rating from the voters now and anything can easilyshift sentiment to the other side. I believe that as soon asPelosi announces a vote, the deal is done. Watch for it.

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