FINANCIAL FREE FALL

Two of the nation’s biggest financial banks have collapsed. Others are in trouble. Real estate markets keep dropping. Stock prices have been plummeting. And despite reassurances from President Bush and Treasury Secretary Henry M. Paulson Jr., an air of desperation has spread through the financial system. For an economy built on easy credit and complex investment schemes, much of this seems inevitable.

The weekend tumult has transformed the U.S. financial community, cost American taxpayers untold billions, and wiped out or severely limited many stock portfolios.

Experts are almost uniformly gloomy and unable to foresee an end to the downward spiral. Most of them look – so far in vain – for a bottom to the housing market and the stock market. They hope for a long climb back to some sort of stability and normalcy, which can only come with financial institutions and investors facing the reality of their risky behavior without government bailouts. The government rightly chose this path by refusing to prop up Lehman Bros., a large investment bank that was forced into bankruptcy.

But to get from here to there requires not only realistic planning but also a certain amount of blame casting. The crisis began with a collapse of the markets for housing and mortgage-backed investments. Both had ballooned beyond all reason through the greed and shortsightedness of both lenders and borrowers and a government obsessed with deregulation instead of tending the store.

The leaders of the huge companies that made multiple billions off the ballooning markets and increasingly complex investments deserve no reward for riding the upward spiral until it collapsed and headed downward. The Federal Housing Finance Agency made a good start by blocking the lavish exit packages of the fired chief executive officers of Fannie Mae and Freddie Mac.

The New York Times Dealbook column spotted a Sunday announcement by the Federal Reserve that it would take riskier assets in exchange for emergency loans through the Primary Dealer Credit Facility. That is attractive for the troubled financial houses, but can mean that the taxpayers ultimately will be backing junk bonds and subprime mortgage securities.

The column points out that, now that Lehman Bros. is in bankruptcy and Bank of America has bought Merrill Lynch, concern is focusing on the two remaining independent financial giants, Morgan Stanley and Goldman Sachs. Both have suffered losses in share value and climbing rates of insuring their debts against default.

Another giant to watch is AIG, the American International Group, a major insurance company struggling to survive.

Individual holders of mutual funds invested in the failed or failing giants are watching their assets dwindle.

For individual shareholders, another bright spot: Their losses are only on paper, assuming they have enough cash to get by without selling securities at sacrificial prices and enough time for the losses to turn into gains.

This is a difficult and costly correction, but is necessary and long overdue.