It ain't over yet.

Markets are the dominant fact of our lives. They are pervasive and volatile, and yet we continue to be surprised as each peak and valley is upon us.

Last week, we moved to the next phase of the sub-prime mortgage “crisis” as major financial institutions began to succumb to reality, to unwind financial positions and to write-down the value of financial assets. Citibank, Merrill Lynch––the most visible brands in the financial markets––lost billions, and billions more that expected.

How? Just a lot of the same-old, same-old. We have been there so many times over the past quarter century––the Savings and Loan Crisis of the late 1980s, the Japanese market collapse of the early 1990s, the Asian fiscal crisis of the late 1990s, the Dot-com collapse at the beginning of the decade––and each time there are three distinct phases. First, there is the “Gee, it doesn’t get any better than this,” phase.

This is the home-value-as-ATM phase, the NASDAQ hitting 6,000, or the Nikkei nearing 39,000, which was epitomized to me in the late 1990s when a Merrill Lynch broker called our home to propose a product where we would take out a home-equity loan to invest in the stock market. How long had he been a broker? Just a year. This time, the exuberance was manifest in the mortgage markets, where buyers could finance 100% or more of a home purchase, and then pay less than the interest-only cost of the loan for several years.

The problem that these mortgage products claimed to solve is that housing was too expensive, and therefore new products were needed to make things affordable. But the logic was backwards. The housing was too expensive because the financing was too cheap. Take away the financing, sit tight for a while, and the markets will correct. Prices will not stay up if demand dries up. Might take time for people to let go, but reality will set in.

That is the first law of markets. They move. The interesting part of the current crisis is how eager people have been to pronounce how long the correction in the real estate markets will take. This is the “Is it over yet?” phase, and here is a simple rule: If people are still asking if it is over yet, it ain’t over yet. This is the question that keeps people holding on and resisting selling, hoping that the bottom has been reached.

It is only when people give up that the third phase arrives, the vaunted “capitulation" phase. This is when fear sets in, when hope is lost, and when, ironically, it has already become a better time to buy than sell.

In our present financial crisis, the meltdown has not come yet. Some real estate markets will not be hit so hard because they never rose so high, while others, like Manhattan, will not be hit so hard because of exogenous factors. In the case of Manhattan, the plummeting value of the dollar has already driven home prices down over 25%––in Euros––bringing foreign buyers into that market.

The shining star in this financial moment has been the Federal Reserve Bank. Over the past three years, the Federal Reserve has steadily increased the Federal Funds Rate––the rate at which it lends money to member banks and the primary tool that it uses for regulating the pace of economic activity. The Fed was raising rates not as it normally does to subdue economic growth and tame inflation, but for the simple reason that after the collapse of the Dot-com bubble and 9/11 the Fed reduced the Fed Funds Rate to 1.00% from 6.50%, and within the Fed there was great concern that if rates were not raised, they could not be lowered again in the event of a new crisis.

Yes, the logic seems odd––to raise rates for the purpose of being able to lower them––but the fear was real. If there were to be a new crisis––such as the one that is now upon us––and the Fed Funds Rate were still at 1%, the Federal Reserve would have few effective tools for addressing that new crisis and supporting the financial system.

And through it all, Japan loomed as a lesson of how bad things could get if the central bank was left with no tools in the toolbox. Japan, as some might recall, was looming as the new world economic colossus in the late 1980s with their stock market and real estate prices in the stratosphere when the bubble burst and values plummeted by as much as 75%. Faced with price deflation, Japan’s central bankers proved unable to thwart the decade-long recession that ensued––even as they pushed interest rates down to 1/10th of 1%––with devastating social and economic consequences.

Fortunately, in the months ahead, this will not be our challenge. The Federal Reserve retains control over the monetary levers that it needs and unlike the Japanese, American consumers continue to spend money through thick and thin. The difficult choices will be on the regulatory and policy side. Specifically, with a presidential election looming, Washington will be faced with the decisions of how much pain can be tolerated before the bailouts begin.

There will be hard choices ahead, but even the resources of the federal government cannot forestall the pain that comes during a major market decline and new regulation always seems to be designed to address the last crisis rather than the next one. The question that will endure––from one market bubble to the next––is whether, when faced with things that appear to be too good to be true––a no-cost mortgage for example––people might pause for a moment before they sign up and consider that maybe they are.