Best- and worst-case economic scenarios

Specifically, the Fan-Fred takeover does nothing to help homeowners who can't refinance a home loan because their property is assessed for less than they owe. It also may not be enough to draw in buyers, who are focused more on the risk of declining home values than on the upside of a slightly lower mortgage rate.

"I've sat in open houses, and you just can't get people to make an offer," says Edward Cudahy Spalding, a real estate broker in Fort Lauderdale. "You've got to reinflate values in the housing market. I don't know how you do that."

Without more relief for homeowners and consumers, the housing-led recession is likely to deepen. In this vicious-circle scenario, the housing slump depresses consumer spending, leading to job cuts and thus forcing even more foreclosures and bigger spending reductions — in other words, the mirror image of the virtuous circle.

Vulnerable sectors include finance; nonresidential construction, which tends to follow homebuilding downward with a lag; and retail, which has so far lost only a modest number of jobs nationally relative to the size of the sector.

Away from Wall Street, the mood is glum. Douglas S. Bartlett, owner of Bartlett Manufacturing, a maker of printed-circuit boards in Cary, Ill., says competition from China has forced him to cut employment nearly two-thirds since 2000, to 87. He hasn't felt any reprieve from the dollar's recent depreciation against China's currency. Says Bartlett: "Fortunately for us, there's been enough of our competitors going out of business that we're able to pick up their work."

More from Businessweek.com Uncle Sam saves Fannie and Freddie Bartiromo: Paulson on housing bailout, next steps Fannie and Freddie's open-ended future

In Sacramento, restaurateur Ali Mackani was forced to shut down his fashionable Restaurant 55 Degrees shortly after Labor Day because of slower-than-expected commercial and residential development in the area, which he had been counting on to produce customers.

Today's business failures ripple across the economy, triggering more failures. And when the financial system is crippled by losses, the hoped-for V-shaped recovery can flatten out into a wide-bottomed U, says Dan North, chief economist of Euler Hermes ACI, a North American unit of Germany's Allianz Group that insures accounts receivable. North says that because of business failures, the number of insurance claims processed by his company was up 80 percent in the first six months of 2008 compared with a year earlier.

Hedge your bets
It's easy to imagine either scenario unfolding, good or bad. And really, that's the whole point. Blind conviction has not served us well. On the one hand, the credit crunch has embarrassed optimists, like Federal Housing Finance Agency Director James B. Lockhart III, who averred on March 19 that Fannie and Freddie "will continue to be safe and sound" and called the idea of a bailout "nonsense."

In his new book, "The Subprime Solution," Yale University economist Robert J. Shiller says regulators suffered from an "inability to believe that there could ever be a housing crisis of the proportions we are seeing today."

On the other hand, it would be equally wrong to assume the worst and get into a defensive crouch, as some investors have done. Prices of some derivative securities are so low that they seem to factor in a complete collapse of the U.S. economy.

And yet investors who smell a profit opportunity in those assets are holding back because they worry their prices could go even lower before rebounding.

Ricardo Caballero, a Massachusetts Institute of Technology economist, wrote in the Bank of France's Financial Stability Review in February that "in today's market, uncertainty has led every player to make decisions based on imagined worst-case scenarios."

What to do? Whether you're inclined toward the virtuous circle or the vicious one, hedge your bets. Because as the Fan/Fred takeover shows, just about anything can happen.

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