Hold course.

Diversify investments. Don't worry, the markets will recover. That's the message of John Waggoner, a personal finance journalist for USA Today, in his slim volume called Bailout.

Ultimately, this counsel may turn out to be right. However, in the meantime, it's difficult not to feel shell-shocked over recent events that began last spring.

Bear Stearns, one of the larger investment banks, failed in March. Suddenly, no one would loan it money. Many feared that money loaned to it would never be repaid, and the once mighty institution was quickly done, tainted by overexposure to subprime loans whose values were whooped up by the powers that be.

Bear was sold to JP Morgan Chase at flea market prices that virtually wiped out the equity of Bear shareholders. But this was no ordinary collapse. If Bear went down, market observers and central bankers warned, others would likely follow. When it collapsed, writes Waggoner, it had a ripple effect.

"It nearly crippled the short-term money market, the lifeblood of modern finance. Bank lending ground to a halt. Municipal financing, which pays for roads, schools and other daily essentials, evaporated," he writes.

But the author, who seeks to reassure the reader in this hurriedly written book, believes that our financial markets will come back. Waggoner assures us that by staying invested, and by diversifying across several asset categories, things will come out fine in the end.

"The economy will recover, earnings and personal income will rise and life will be good again," he predicts.
Well, sure they will. And the Chicago Cubs will win the World Series someday. But will it be anytime soon?

Markets have gone through tough times before, but could it be that these times will be longer and more destructive than in the last 60 years? Could it be that we will see a repeat of the Great Depression or follow the same path as Japan and live through a decade-long recession? As bad as things have been at this writing, that would mean the pain has just begun.  

Indeed, after this book went to press, Lehman Brothers filed for bankruptcy; Merrill Lynch, the nation's biggest retail broker, had to be sold. And the once unthinkable happened: A giant insurer, AIG, blew up and was taken over by the federal government.

I say unthinkable because in the Great Depression, when thousands of banks went under or came close to dying, insurance companies, which are generally run on conservative principles requiring large reserves, weathered the storm.

There is another alarming aspect of the recent crack-up that Waggoner doesn't discuss. In previous economic disasters, Americans and various units of government never had such large levels of private and public debt. Waggoner says the public debt is some $9.4 trillion.

But that's not counting the off-budget obligations. Add those in, says former U.S. Comptroller General David Walker, and the number is actually around $53 trillion, or some $455,000 per household!  

Meanwhile, individuals haven't been doing much better than their government. New borrowing by private households went from less than $100 million in 1972 to a little over $1 trillion in 2004, according to the Federal Reserve. What will happen to heavily indebted individuals who lose jobs if we're in a long recession or a depression?

The ripple effect of Bear Stearns' fall, says Waggoner, is that people who had done business with the bank just before the crack-up feared that its woes could pull them or their company down with it. Similarly, one can consider the dangerous mental state of tens of millions of Americans now. Will many of them be afraid to put money back in the stock market?   

As I write this, many investors seem little interested in anything other than Treasurys as a port in the storm. Yes, I suppose things will come out all right in the end. However, in the meantime how many lives and companies will be wrecked? How many more people will lose their homes?

These are questions that must be posed after the demise of several financial institutions and the blunders of the central bank, Congress and different presidents. And unfortunately, it is not clear today, in the midst of the storm, that there will be a happy ending soon. Holding course may ultimately be the right option for most Americans, especially for those with years to recover. But, for many others, including those who are retired on or the verge of retiring, holding course may hurt.

Waggoner and others are focusing on the short term, and they eventually need to seriously examine structural changes in the financial system on both Wall Street and in Washington.

Our system of cheap money, of easy credit, of radio ads that shout out that anyone can get a 100% financed car loan ("Don't bring money; just bring your pen!")-as well as the idea of home ownership as a right of every American no matter what his or her financial state-should be ended. Yet it's a system subscribed to by the leaders of both major political parties. They're usually reluctant to tell voters unpleasant truths until they are comfortably elected or re-elected.

It is a system backed by big financial institutions, which often have been rescued from their mistakes by the taxpayers. Talking about this system, former Fed chairman Alan Greenspan, who spoke proudly of his actions a few years ago, can now eulogize the era of easy money and subprime loans: "I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership initiatives distort market outcomes," Greenspan wrote in his Age of Turbulence. "But I believed then, as now, that the benefits of broadened home ownership are worth the risk."  

Now we'll all pay for those risks in higher inflation, bigger debt and rising unemployment. Greenspan's system, supported by almost everyone on the Hill and in the White House for the past two decades, must be rejected.

Otherwise, the second part of Waggoner's prediction will also come to pass: "Somewhere in the next recovery will be seeds of the next new financial mania."

People should learn from history, especially when it is so painful to repeat it.