What would financial Armageddon look like?

By Anthony Reuben
Business reporter, BBC News

The US government's $700bn (£376bn) bail-out package is designed to avert a complete financial meltdown.

The US government is going to great lengths to avoid financial Armageddon

Many people have compared the current financial crisis with the Wall Street crash of 1929 and the Great Depression of the 1930s that followed it.

Yet current events are clearly not in the same league.

"I don't think so, considering that the Great Depression had thousands of banks failing and people losing their life savings, 25% unemployment and social unrest and tent cities of the poor," says Allan Sloan, Washington Post and Fortune magazine columnist.

Could be worse

The US government may end up spending trillions of dollars dealing with the problems, but so far, with unemployment at about 6% and arguments going on about whether the US economy is even in recession, it seems frivolous to mention the current crisis in the same sentence as the Great Depression.

However bad things seem at the moment, they could be a great deal worse.

The Financial Times referred to last Friday's stock market recoveries as marking the end of the "Armageddon discount", and yet markets fell again on Monday, suggesting that investors may not be discounting Armageddon.

So what would it look like?

"It would be like an exaggerated version of last week," says stock market historian David Schwartz.

"There will be frightening news, frightened investors and news stories suggesting the end of the world has come."

Going bust

There would also be a widening of the types of companies going under.

So far, many of the firms going bust have been in the financial sector, but if things get worse there are many other vulnerable sectors.

In the 1930s, people would hoard money rather than keep it in the banking system Edward Chancellor, financial historian

Analysts are looking carefully for the most heavily indebted companies, because there is concern that if banks do not resume lending to each other, then those are the firms that will fold.

Of course, more companies going under would mean hefty job losses.

Insurance problems

The other threat to non-financial companies was the danger that prompted the Federal Reserve to bail out the giant insurer AIG.

"What AIG threatened was a non-functioning derivatives market," says financial historian Edward Chancellor.

Many non-financial companies use the derivatives market as a sort of insurance policy.

Airlines use it to protect themselves against the price of aviation fuel rising while exporters may use it to offset movements in currencies.

Local currencies

In the current crisis, there is still relatively strong confidence in the banks and financial system as a whole.

"In the 1930s, people would hoard money rather than keep it in the banking system," Mr Chancellor says.

"They started coming up with local currencies instead of using dollars."

All these are bleak prospects, but there always comes a point at which the economy hits the bottom and things start improving.

"The problem with stock market bottoms is that very few people see them - there is no announcement," Mr Schwartz says.

"Everybody who has shares that they want to liquidate has done so and shares start rising because there are no sellers left."

At that point, people start piling into the market and the recovery is underway.