And now what?

Let’s assume that the House of Representatives can get its head around passing the “banking system reinforcement act” aka The $700 billion Bonus Check to Wall Street Fatcats. (Are the odds of congressmen doing what’s right rather than trying to save their seats higher than 50%?)

If the act passes, maybe some liquidity starts to dribble through the system. Maybe banks start to lend to each other money at something other than a 500 basis point margin over the risk free rate.

But even with those improvements — and they also are uncertain — it will still be months before credit markets return to normal. It will be years before the housing market, which has accounted for up to 30% of GDP over the last decade, recovers. And it will be decades before we shrug off the memory of this debacle. And it may be a 100 years, if ever, before foreign buyers consider the greenback to be the reserve currency of choice.

The stock market crashes — ’87 and ’00 — we all use as benchmarks for the current debacle were superficial revaluations, games market participants were playing with each other. They may have scared people, but they didn’t touch the core of the economy. (The ’87 crash was a equity pricing re-adjustment after a 30% rise in rates, and the ’00 crash was a revaluation of overpriced Internet companies.) In contrast, this time around the stock market’s collapse is a trailing indicator of a fundamentally sick economy.

The cratering housing market is just one domino in a circular cascade. Yesterday we learned auto sales were off 26% in September. As factories and dealerships close, their workers dine out less, get fewer haircuts, pay fewer taxes. Municipalities pave fewer roads and lay off teachers’ aids. Fewer new homes will be built. Homeowners bail out of houses they would have never bought without reckless, eyes-shut lending. Newspapers close as ad spending declines. Consolidating banks lay off staff.

In short, there’s a lot of adjustment ahead.

Look for the market to step sideways some months, then tumble 10% lower some weeks. Over, up, over, DOWN, over, DOWN. Repeat. Some kind of sick dance-step.

The steps down will reflect the gradual process of cash holders trying to pick bottoms only to discover that the tide of bad news keeps flowing and they have to bail out, driving prices (and potential returns) to a new level of cheapness. Eventually, buyers and sellers will find the right price for all the cruddy news we’ll see emerging. Take a look at the stock market between 1929 and 1933… it took many exchanges of ownership and nearly four years to find the right valuation levels. (Great graph and prognostications here.)

The next news to watch is initial unemployment claims tomorrow at 8.30AM. God forbid it comes in at 600k AND Congress doesn’t pass the bailout.

But again, I think we’re in for a rough ride even if the House joins the Senate and passes the bailout. Though the ride may be slow and grinding and with occasional 4% upticks, it will be inexorably lower when looked at on a month to month basis.

(BTW, does anybody know what Harry Reid is talking about when he says a major insurance company is teetering on the edge of insolvency?) Today the Dow closed at 10,831 and Nasdaq closed at 2069.

Update: Joe Nocera gives a good recap of the (first) meltdown two weeks ago.