How Bad Can Crisis Get? Watch Credit, Not Stocks

As global markets continue to tumble, many investors are worrying just how bad things can get. The answer: Pretty bad.

Watching market benchmarks like the Dow 10,000 fall by the wayside are bad enough. But what may be worse is the realization that while stocks eventually will recover, those hurt by the credit crisis may not.

And that, indeed, may be the true legacy of the current financial crisis.

"People can handle a stock market that goes down. Emotionally you don't like it, it hurts you, but you have some optimism that it will come back," says Dennis J. Barba, managing partner of the Oxford Group of Raymond James. "When you need to borrow money and you can't, that's something you might not be able to overcome as a business or individual. To me, that's the scariest thing of what would happen."

Investment advisers are counseling clients essentially to stay out of the markets. This is neither a buying nor a selling opportunity, they say, except for those who desparately need to liquidate.

"If we can't get confidence back in the credit markets, I don't see how equity markets move that much higher," says David Twibell, president of wealth management for Colorado Capital Bank.

Is global meltdown here? See video at left.

Still, "I think we have gone to a point where history isn't a particularly good guide anymore," Twibell says. "Based on historical patterns, we should see a bounce here."

Dire predictions abound: Some see a steep recession, others go so far as to predict a depression. Though it wouldn't be on the scale of what gripped the US in the 1930s, a depression would still inflict severe damage across the economic spectrum.

"Just the speed of communication would lend itself toward a more rapid decline than the 1930s and a more rapid recovery," says Martin Weiss, president of Weiss Research. "Suffice it to say that what used to happen in months can now happen in hours. It's a whole different time perspective. And that's a good thing. The longer it's drawn out the more opportunity it has to spread."

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Weiss sees a government still unable to grasp the depth of the credit problems and without a concrete plan to solve them beyond market meddling. And while the focus is on bailing out bad banks, it should be on working with good banks that have the power to rescue the economy from its ills, he says.

Weiss also scoffs at the Federal Deposit Insurance Corp's estimate that only 117 banks are in danger of failing. In fact, he says, the number is closer to 1,500 because the FDIC's list doesn't include large banks that have failed or been forced to merge this year.

The only solution, he says, is for the government to watch its own back—by making sure government-backed securities don't suffer the same contagion that has been afflicting private debt—and by letting the free market take care of business.

"What they're going to have to do is abandon all their rescue efforts. It sounds almost unthinkable now, but that's what they should be doing and be forced to do," Weiss says. "They're going to be down to a situation where they're going to have to say it's either us or them."

Investors Getting Panicky

To be sure, the lack of volume present in Monday's stock slide suggests a more orderly selloff than might be expected. The low volume points more to a lack of buyers than an onslaught by sellers.

Much of the selling, indeed, is being attributed to hedge fund managers bailing out of positions as their fiscal year comes to a close and institutional funds looking for safety amid the storm.

"Every time I've seen a bad market like this you have to get everybody scared out of their minds and ready to throw in the towel before it ends," Barba says. "I can tell you that hasn't happened. We haven't had 30 people call saying they want to dump everything."

Still, the fear lurks, and Barba notes that he has had people calling up to say "I can't sleep at night anymore."

The market's most oft-cited gauge of fear, the CBOE Volatility Index , soared past 50 today for the first time in nearly 20 years.

It's simple uncertainty that seems to be driving behavior right now as market pros can find virutally no models or patterns of history that provide a roadmap through the current crisis.

"We've got such an extreme amount of fear and angst in this market, you would expect we would see a bottom getting put in and we would move a bit higher for a period of time," says Twibell of Colorado Capital Bank. "I'm not sure when we get that."

Even another move by the Fed to cut its key lending rate is unlikely to have much impact, most analyts say, though there is some optimism that a coordinated effort among the world's central banks to provide liquidity could help.

"I think we're probably going to even lower than 10,000 (in the Dow). It looks like the global meltdown is upon us," Dave Rovelli, managing director of US equity trading for Canaccord Adams, said on CNBC.  See video above.

Global central bank action could help, Rovelli added, but "until that happens, I don't think we go higher. Maybe we'll have a bear market bounce, but that's about it."

© 2009 CNBC.com