This week the Fed altered their end-of-meeting statement by just a few words, but those words have a lot of meaning. It seems they are paving the way to a new round of quantitative easing (QE2), if in their opinion the situation warrants it. A trillion dollars of new money could soon be injected into the system. Tonight we explore some of the implications of a new round of QE. Let's put our speculation hats on, gentle reader, as we are moving into uncharted territory. There are no maps, just theories, and they don't all agree. (Note: this letter may print a little long, as there are a lot of charts.)

But first, as a reminder, next Wednesday, September 29 (9:00 AM PST/12:00 PM EST), I will be doing a special "webinar" with Jon Sundt, President & CEO of Altegris Investments, where we'll discuss the forces that are shaping today's economy and their potential influence on financial markets (the very things I write about in this week's letter and in my new book!). This is an excellent opportunity to learn about alternative investment strategies designed to provide noncorrelated diversification for your investment portfolio in the "new normal" economy. We'll set aside a lot of time to answer your questions.

A replay of the call will be available for two weeks starting Thursday, September 30, for registered participants only. Even if you can't make it at this specific time, I recommend you still register so you can listen to the replay at your convenience after the event.

You can register by going to www.accreditedinvestor.ws and signing up for my free accredited letter, and a representative from Altegris will call you to give you the details. Sadly, this is available only to accredited investors ($1.5 million net worth and up) and/or registered financial professionals, due to current regulations. I will be giving a preview of the conclusions from my new book, The End Game, which I think you will find interesting. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

I have been writing for almost a year that the next shoe to drop on US banks would be commercial construction lending. Today we look at some hard numbers. We look across the pond to sort out the problems in Europe. We look at the consequences of the losses stemming from Lehman. Then we look at one of the more serious consequences of the banking crisis, one that will bring the crisis home to you. Finally, we look at what the various governments of the world must do in response. It may not be fun, but it should be interesting. And it is important. Feel free to forward this letter to anyone who asks why we not only need the bailout but will need even more coordinated government action.

But first, let me offer a note of optimism before I serve up the not so good news. This is not the end of the world. There are a lot of very positive things happening in the US and the world. Companies are creating new inventions. Much of the economy, including health care, is moving along fine. I have lived through two serious recessions (1973-74 and 1980-82), and the point is that a free-market economy will find a way to eventually get back to solid growth. Recessions are simply part of the business cycle. Congress cannot repeal the business cycle. This will not be the last recession of my life. I hope to live long enough to go through 4 or 5 more.

Depressions are caused by governments making major policy mistakes. And we have made some in the areas of not regulating mortgage lending, allowing the five large investment banks to increase their leverage to 30 or 40 to one in 2004 (what was the SEC thinking?), and failing to oversee the rating agencies. That is behind us. It will make a normal recession deeper and the recovery longer, as I have been forecasting for some time.

"A tournament, a tournament, a tournament of lies.
Offer me solutions, offer me alternatives and I decline.
It's the end of the world as we know it and I feel fine.
(It's time I had some time alone.)"

- Lyrics from R.E.M., 1987

Flying last Tuesday, overnight from Cape Town in South Africa to London, I read in the Financial Times that Republican Congressman Joe Barton of Texas was quoted as saying (this is from memory, so it is not exact) that he had difficulty voting for a bailout plan when none of his constituents could understand the need to bail out Wall Street, didn't understand the problem, and were against spending $700 billion of taxpayer money to solve a crisis for a bunch of (rich) people who took a lot of risk and created the crisis. That is a sentiment that many of the Republican members of the House share.

As it happens, I know Joe. My office is in his congressional district. I sat on the Executive Committee for the Texas Republican Party representing much of the same district for eight years. This week, Thoughts from the Frontline will be an open letter to Joe, and through him to Congress, telling him what the real financial problem is and how it affects his district, helping explain the problem to his constituents , and explaining why he has to hold his nose with one hand and vote for a bailout with the other.

Just for the record, Joe has been in Congress for 24 years. He is the ranking Republican on the Energy and Commerce Committee, which is one of the three most important committees and is usually considered in the top five of Republican House leadership. He is quite conservative and has been a very good and effective congressman. I have known Joe for a long time and consider him a friend. He has been my Congressman at times, depending on where they draw the line. I called his senior aide and asked him how the phone calls were going. It is at least ten to one against supporting this bill, and that is probably typical of the phones all across this country. People are angry, and with real justification. And watching the debates, it reminds us that one should never look at how sausages and laws are made. It is a very messy process.

I think what follows is as good a way as any to explain the crisis we are facing this weekend. This letter will print out a little longer, because there are a lot of charts, but the word length is about the same. Let's jump right in.

We are entering the next stage of the credit crisis, and one which is potentially more troubling than what we have seen over the past year, absent some policy reactions by the central banks and governments world wide. The crisis was started by an intense run-up in leverage by financial institutions and investors world wide, investing in increasingly risky assets such as subprime mortgages and then the realization that leverage could hurt. The deleveraging process started to intensify last year about this time. The easy part of that process has been just about done. Now is the time for the really hard work. It will not be pretty. In this week's letter, we look at the process and think about its implications for the markets and the economy, and visit some data on the housing market and unemployment.

And just for the record, the problems I am describing in this letter are very real. But we will get through them, as we have always done. This is not the end of the world. There are a lot of very good things happening here and there. As we will see, for most smaller banks, it is business as usual. In general, in most places and for most people, life is going on just fine. There are opportunities being created. The markets will find new solutions. But there is some more short-term pain for many market participants, and we need to be aware of the problems and see if we can avoid them for ourselves.

But first, let me ask you for some help. I get to travel a lot with my daughter and business partner Tiffani (actually she runs the business) and meet new people. Over the years, she has become as fascinated as I have with their individual stories. Everyone has a story to tell or a lesson to teach. As I announced a few months ago, we have decided to write a book (or series of books) about those stories, looking at the differences in perspective between old and young, retired and working, those who are wealthy and those who aspire to wealth. What are the differences in attitudes, in work habits, in how you manage money, in how you look at the future, and a score of other items? How do all of these things correlate?

When is the credit crisis going to end? How will we know? The credit crisis is getting ready to enter its second phase. This week we examine what that means, and what the economic environment will look like over the coming quarters. We also (sadly) re-visit Freddie and Fannie and examine the risks that they put into the markets. Risks, by the way, that were sanctioned by regulators and encouraged by a Congress that took in hundreds of millions in campaign contributions and lobbying fees. We (the US taxpayer) have taken on a huge risk and potential loss for that paltry few hundred million. Sadly, those who encouraged that risk will by and large be voted back into office rather than ridden out of town on a rail (an old US custom, rather barbaric, but one which should maybe be revived for this purpose). It should make for an interesting letter as we count down the last days of summer.

But first, last winter I mentioned that I am looking for private equity and venture capital funds and investment professionals who specialize in those deals, and asked those who would be interested in looking at the potential deals I see from time to time to write me. I had a nice response, but my filing system is somehow inadequate to the task and I seemed to have misplaced about half the respondees. If you have not heard from me lately and would like to be "at the table," just drop me a note at this email address. And now, let's jump into the letter.

Yet another crisis confronts us, as we will have to deal with the aftermath of a rather large number of bank failures over the next year, which is likely to overwhelm the ability of the FDIC to insure your bank deposits. Today we look at the banking system, the FDIC, and Freddie and Fannie. It's not pretty, but as realists we must know what we are facing.

But first, I just want to say I am glad that Richard Russell is doing fine. For those who do not know, he suffered a mild stroke last Friday. I talked to him yesterday, and he was a little tired but doing better. He has decided to cut back his writing schedule and relax a bit more, which is a good thing. At 84, he has written a daily (and sometimes lengthy) commentary and has been writing the monthly Dow Theory Letter since 1958. He is the dean of newsletter writers. He has forgotten more than most of us will ever know about the markets.

His doctor told him he needed to seek some balance in his life and cut down on the stress. I know how much it takes to write my one letter each week; I can't imagine what it takes to write five. Basically, his plan is now to post his stats and only write about the markets when something important is happening, about every two weeks. I hope he sticks with that plan, as I want to be sharing dinner and drinks with him for many years to come. I am sure you join me in wishing him and his lovely wife Faye all the best and a healthy and quick recovery.

This week as I am in Nova Scotia, where my bride "suggests" I will be far removed from any internet access, I am pleased that my friend Art Cashin is allowing me to reproduce a series he has been writing about in his privately circulated "Morning Comments" that I think you will thoroughly enjoy. Art's thesis, and I agree, is that we may be at a very important "tipping point" in the global economy. To help his readers understand why that may be, he has written an essay explaining how banking, money, central banking, interest rates and other factors "fit together." He has done a very good job of explaining this complex subject in simple terms. For those of you who already understand all these details, you will now have some simple ways to explain them to your friends or give to your kids. For the rest of us, it is nice to be able to see how the puzzle pieces fit.