What does this mess mean for my finances?

My 401(k) has been pummeled this year, as have most people's. I'm 31 years old, so I still have many years until retirement. If history is our guide, will the market tanking and allowing me to buy shares of my funds at a much cheaper price end up actually being a good thing over a long period? Or is that just something I am telling myself so I can sleep at night?  
— Peter B., Arlington, Va.

If history is your guide, the odds are in your favor. Unfortunately, the current financial mess is like nothing that’s ever happened before.

There have certainly been financial panics on the scale of what we’re currently seeing. The Great Depression comes to mind. But like every financial cycle, the specific circumstances are unique.

The modern financial system is a marvel of man’s creation; trillions of dollars of capital fly around the world with the speed of electrons. While past panics were confined to stocks or bonds, we now live in a world of complex, interdependent securities that have been created only recently. Some of the professional investors who created these securities are now learning (the hard way) that these pieces of paper are, in fact, much more complex and risky than their computer models predicted.

That uncertainty is at the heart of the current crisis. When the stock market crashed in 1987, for example, the damage was widespread but highly visible. But within a few days, the panic was over and the market resumed its upward climb.

Today, while it’s clear the financial system has taken an enormous hit, no one knows exactly where the damage is. Think of it like a ship taking on water, with no way to figure out where the leaks are. The crew is now desperately trying to pump the water out of the hold while it searches for the leaks. Despite reassurances that everything will be fine, if the ship keeps sinking, you’ll probably see more people decide to take their chances in a lifeboat.

How likely at this point is it that the current economic slippery slope is going to take us all the way to the crash of the Federal Reserve System?
— Angela H., Portland, Ore.

At this point, it’s hard to rule out anything: There has never been a panic quite like this one. But for the moment, the Federal Reserve System — and the U.S. banking system — are in better shape than the events of the past few weeks would lead you to believe.

For one thing, the Fed and the Treasury have now acknowledged that the turmoil in the U.S. credit market is too big for the Fed to handle by itself. That’s why Treasury Secretary Hank Paulson and Fed officials have been meeting with congressional leaders to work out a plan for  cleaning up the mess.

It’s also worth noting that banks that rely heavily on depositors for their capital are in much better shape than the big investment firms that bought big piles of mortgage-related paper with borrowed money. That’s why Bank of America and Wachovia have emerged as buyers for these failed companies. For the moment, it looks like the banking system as a whole has a fairly comfortable cushion of cash.

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