As leaders work to prevent a political and psychological crisis from turning into a financial one, history offers the only real guide on what to expect when the smoke clears.

That attack, the first major thrust north by the surprisingly powerful Southern rebels, led President Abraham Lincoln to issue his Emancipation Proclamation – and open a new chapter in American civil and business life, a new era of liberty for people and markets.

Likewise have most major events in U.S. economic history led to consequences unimagined by key actors at the time. And so it will probably be with this attack. Sources across the country told me Tuesday that they believe that the unexpected consequence over the next few days and months could be a stock-market rally led first by promises by the Federal Reserve to provide all necessary funds to staggered banks and brokerages and next by vast deficit spending by Congress to shore up the country’s defenses.

Michael Stutzer, professor of finance at the University of Iowa, points out that Tuesday’s events were a civil and emotional crisis, not a financial crisis. An emotional crisis, he said, can lead to a financial crisis only if mishandled by government authorities. “A financial crisis is what happened in Japan, where people learned that not only were all the stocks they held were overvalued but that their government had a hand in leading their banks to bankruptcy,” he said. “Nothing like that is happening here. But what does have to happen now is that the Fed must act to prevent a ‘contagion of fear’ from spreading and leading people to withdraw money and stop buying things. That would lead to a recession and thus to a real financial emergency.”

A few predictions

What are the likely immediate consequences when the US markets reopen later this week or next?

Anthony Kolton, chief executive of Markethistory.com in Chicago, has researched the past 100 years of events that led the United States into war. He forecasts with confidence that the major indexes will open with losses of 5%, then quickly recover by the end of the following trading week to remain unchanged at pre-catastrophe levels. “If there is a big opening plunge, I think you’ll see a total recovery over the next five days,” he said from Manhattan.

Kolton, who was en route to a meeting at the World Trade Center when the buildings were hit, said he also believes that the United States does not face a financial crisis just because the buildings that were destroyed stood at the center of U.S. financial life. The reason: After the 1993 bombing of the buildings, he says, most companies spent millions to build disaster recovery systems and back up all their accounting far off site. “We’re going to recover,” he said.

Steve Milner, managing partner of the worldwide financial planning firm Squar Milner in Newport Beach, Calif., said he is most worried about the consumer, not business. Based on conversations with clients, he believes that people will react with fear — and fearful people rein in their spending on everything from vacations to home remodeling and stocks. That will be a real, not an imagined, economic event, he believes, that could badly damage a U.S. economy that is already sputtering.

Milner also notes that many major financial institutions that he does business with were already inclined to be sellers of the recent decline, not buyers. But that could turn around. “People who were inclined to sell might be more inclined to sell now – but I doubt it,” he said. “There is a cynical part of me that says financial professionals will realize that life goes on and will decide to be buyers.”

Vic Niederhoffer, a longtime trader for financier George Soros and his own accounts, says that he also believes that a big down market will find buyers. “I really hate to sound mercenary, but I have received many messages from traders who say that they think this will be a terrific opportunity to buy. Whether you look at the John F. Kennedy assassination, the Eisenhower heart attack, the Warren G. Harding ptomaine poisoning or airline crashes, usually disasters provide the greatest times of opportunity,” he said.

Niederhoffer, a student of economic history, said that in the past disasters have led to a tremendous boost for local and national economies as capital infrastructure gets rebuilt with the most modern equipment. Those two buildings alone will require massive outlays of funds – possibly provided by the Fed or Congress from the U.S. Treasury – to build miles of new fiber-optic lines, buy the latest data-transmission switches, and possibly tens of thousands of new computers and software.

“Everyone will chip in to help and this will turn out to be a transitory event,” Niederhoffer said. “It may cause a temporary slowdown in the U.S. economy and a big disruption in the supply chain, but there is no evidence that declines in products or earnings or commerce have anything to do with stock prices anyway. In fact, there is no evidence to suggest that stocks do any worse in recessions than they do in better times.”

Mr. P, a hedge fund trader that I have quoted in past columns, said he likewise believes that the first day’s move could set a bottom to the market. “This is very bad for bonds, very good for stocks,” he said. “This act of war, with the magnitude of the loss of life, will lead Congress to engage in deficit spending like the world has never seen — selling billions of dollars of new government bonds to cope both with the reconstruction of New York and the build-up of the American military.”

Always, history offers perspective

So what if these scenarios don’t pan out? The global financial system was already in bad shape before Tuesday and sellers of stocks were swamping buyers with growing intensity. If worried investors decide to put all their personal funds in a lockbox and the Fed and Congress stand aside, you could look to the last major financial crises for the floor in the market.

The October 1987 crash left the Nasdaq at 323 at its nadir, a level reached again four years later in October 1990 at the moment of greatest panic over oil supplies during the Gulf War against Iraq. If the markets had risen from there in a straight line that approximated the historic 6% return of stocks, that index would be at around 690 today instead of 1,680.

That could be a real floor, but it’s unlikely to transpire if authorities do their job and thus avoid the fate that befell Gen. George McClellan two months after Antietam. President Lincoln replaced him with Ambrose E. Burnside after complaining about McClellan’s failure to press his advantage after victory. His comment: “If you don’t want to use the Army, I should like to borrow it for awhile.” The Bush administration likewise has a vast set of financial weapons at its disposal to battle this assault, and the public will replace it if used unwisely and too slowly.

Regards, Frankie Wong

Peter Fray

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