As the Forbes.com Investor Team gathered for a two day e-mail discussion, PNC Financial Services was going to use some of its share of the government's money to buy Cleveland's National City. The markets also whipsawed, dropping 6% Monday but climbing 10% the next day on news that the commercial paper market has seemed to be responding to interventions by the Federal Reserve.

Meanwhile, rumors abound that the government will support General Motors in an acquisition of Chrysler. Investor Team stalwart Vincent Farrell believes that the government might really be trying to save the Pension Benefit Guaranty Corp. "The auto industry employs over 145,000, but the industry supports more than 600,000 retirees," Farrell writes.

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The global financial crisis

Farrell's observation just underscores how complicated the financial system really is. Randy Carver, a financial adviser with Raymond James, points out that the PBGC, much like the banking system, works in part because people have faith in it. The government can't absorb the failure of Chrysler's pension fund, so the government has to play prevention. These decisions haven't always been on the money. Some very smart people have managed to botch them--from tycoons to legendary authors to Federal Reserve chairmen and presidents.

On Tuesday, Moody's reiterated its negative outlook on U.S. state governments. The ratings agency expects tax revenues to decline. Though Moody's notes that most states entered this downturn with rainy day funds, it has positive comments only for Alaska, Colorado, Louisiana, Montana, New Mexico, Texas and Wyoming, where exposure to the financial services sectors are limited, and natural resources are abundant.

Get ready for 'stag-deflation'
Chinese investment outlook, 2009

Twenty-one states face budget shortfalls totaling $9 billion. New York, New Jersey and Massachusetts are all headed for trouble, says Moody's. They've been bolstered by tourism, but weakening currencies around the world will cut into those profits.

Nick Raich of National City joined the discussion with a forecast for next year--earnings estimates on the S&P 500 will be cut from the current $90 a share, he says, but if they're not cut to $60, which is on the low end of forecasts, then stocks could perform well. Raich and Farrell are both operating from the same set of numbers.

Carver also agrees but warns that the "issue will be what changes sentiment. Barring any unforeseen event (terrorist, natural, etc.), I believe that once the funds start flowing into the markets, we will see a sharp swing up given the record levels of cash world wide."

Street anticipates GDP decline

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So the panel agrees--there's opportunity for the long term but plenty of hidden time bombs that could create short-term problems.

The PNC takeover and 2009 Outlook

Farrell: PNC/NCC merger has a couple of implications. It clearly tells us that the Treasury sees bailing out banks via other banks as cheaper for the government then letting them fail. With the list of favored banks expected to be completed this week, their thoughts will turn to what other institutions need help. Automakers and insurers are knocking on the door, and it looks like the US government will be the largest sovereign wealth fund in the world.

PNC got a great deal. NCC is worth at least twice the price (in my opinion) and probably could have survived on its own. But not getting federal money condemned them so they made the best deal they could. Probably is the best deal for the system as a whole but brutal for the NCC shareholders.

What I am hoping for is actually a short-term end to the rise in the value of the dollar. I am an advocate of a strong dollar, but it seems that the rush to dollars is being triggered by, in part, the massive liquidation of risky trades around the world undertaken by borrowing what were cheap dollars to be invested in all sorts of things. Bailing out of those trades requires buying dollars to pay back the loan. A temporary pause in the dollar's ascent could indicate the liquidation is coming to an end.

I'm also guessing that the election will help the market as it would remove one uncertainty from the equation.

Raich: While I can't comment on the PNC/NCC merger specifically, I want to add to comments made by Vince as to what "other than bank" institutions will need federal help next. The longer the credit markets remain frozen, the faster contagion will spread throughout the global economy. So, I agree investor focus could soon shift off the banks, at least temporarily, to "Who is next?"

The problem with all the government intervention for the markets, though, is just that it is simply going to take time to take effect. It also may have been too late in coming, because we may have hit the point of no return for rapidly decelerating growth and the ripple effect of declining markets.

Let me explain one of those ripple effects and how it impacts profits. To most every intelligent investor, it is clear corporate profit expectations for 2009 need to be ratcheted down. My best guess is the Street is pricing in about a 35% drop in earnings expectations already.

But, this figure could be greater as the ripple effect of say having to add to pension plans because certain accounting assumptions were expecting plan assets to grow 8% to 10% a year, instead of declining 25% or more. Therefore, many companies may have to contribute more than expected in 2009; thereby lowering earnings estimates even more than just doing so because revenue growth is going to slow.

As for currencies, the euro was tremendously overvalued over the past year and could be in for more declines, which could have very adverse effects on those countries linked to the euro. The fact that Denmark raised interest rates last week in an attempt to beef up its currency was interesting. Is it a desperate move? Well, this strategy didn't work for Iceland, which hiked rates earlier this year and ended up making its problems worse by doing so.

Bottom line for all of this, until housing inventories get worked off (which they eventually will) and credit markets begin to function properly again (which they also will too), we will be heading into a deflationary environment as the de-leveraging process for both business and consumers could be more painful than expected. Certainly, the markets have priced in a lot of this already.

But, it is our opinion the process will take longer than expected, and the market just does not have the patience to wait. While we never have 100% visibility, the freezing of the credit markets has made it hard to see the hand in front of your face at this point as to what is going to happen with business fundamentals in 2009. As uncertainties begin to lift, stock prices will start to move higher. Until then, risk aversion is the name of the game.

Farrell: Nick talks about the effect on profits this crisis will have, and that is the critical point to investigate since profits dictate stock prices. The S&P earned $87 in 2007. A recession usually sees a profit decline of 15% to 20%. The lower end of that history would imply 2009 earnings per share of around $70, but let's be super bears and call it $60, since what we are in is unprecedented in terms of credit destruction.

The question then, "Is the S&P valued properly at around 875?" 875 and $60 yields a price to earnings (P/E) ratio of 14.5. That is a fair P/E with what will undoubtedly be a low inflation environment if--big if--you thought that would be trough earnings. In fact, a fair P/E on those earnings would normally be higher.

The level of uncertainty surrounding the potential growth of the world's economies is such that predicting a recovery in profits is uncertain at best. If you were to believe that the government's liquidity push will work, stocks are attractive. If it were to take longer than hoped for to reignite lending, then stocks are attractively priced, but not compelling.

Carver: There are several issues on the table. ... I agree with Nick that government intervention is going to take some time to have an effect. That being said, the announcement today of getting out at $125 billion and the start of banks actually taking cash (PNC and KEY for example) will hopefully help the markets from a psychological level. The real economic impact will take six to nine months, in my opinion. I also agree that PNC got a great deal, and we will see more of these with bank consolidations and takeovers.

I think the focus will start to turn to the national debt post-election, and we may start to see some interest rates rise, which should help the dollar. Is this the next big "thing?" Regardless of who gets elected, we will likely see income taxes go up, which could potentially hurt a recovery, but I feel the bigger issue will be the deficit.

I agree 100% with the comment by Nick--issue will be what changes sentiment. Barring any unforeseen event (terrorist, natural, etc.) I believe that once the funds start flowing into the markets, we will see a sharp swing up given the record levels of cash world wide.

Bottom line for all of this, until housing inventories get worked off (which they eventually will), and credit markets begin to function properly again (which they also will), we will be heading into a deflationary environment as the de-leveraging process for both business and consumers could be more painful than expected. Certainly, the markets have priced in a lot of this already.

But, it is our opinion the process will take longer than expected, and the market just does not have the patience to wait. While we never have 100% visibility, the freezing of the credit markets has made it hard to see the hand in front of your face at this point as to what is going to happen with business fundamentals in 2009. As uncertainties begin to lift, stock prices will start to move higher. Until then, risk aversion is the name of the game.

The other question we are getting is whether we will see increased foreign investment into U.S. companies as valuations drop and the dollar remains relatively low. Personally, I think we will see some increased buying but not outright takeovers, nor do I see this as a catalyst for recovery.

I think most bad news is priced into the markets at this point and that quality companies with low debt-equity are priced properly. ... Those that have higher debt levels will have bigger issues in the coming year. Regardless, I think that for longer-term investors (three to five years), this is a great entry point into the markets. Short-term traders are on their own.

In my experience ... when everyone is bearish, it is usually time to buy ... Once we do see a little recovery, I think that the shorts will have to cover and cash will flow in so managers don't "don't miss the recovery." Anecdotally, it seems that investors are resigned to a prolonged recovery but feel we are at the bottom. They are just looking for reasons to invest rather for reasons to sell

Raich: When there is no one to take the other side of the trade, you need to be a contrarian. Said another way, when the last bull turns into a bear, you probably reached a market bottom. I certainly don't question that sentiment has turned very negative and that is actually a bullish indicator.

However, with credit still tight despite all the best efforts of the government, the consensus can be right and trends tend to last longer than one might expect. To which markets can then irrationally overprice stocks during the good times and then irrationally under-price stocks during the bad times.

I do want to stress it also only pays to be a contrarian at the inflection points. In no way am I saying stocks are not cheap. Even if 2009 earnings estimates get cut from $95 (where the current consensus is) to $60, which is about a 35% reduction, stock prices should have little downside.

By the way, Vince, your math is similar to the math I used (assumptions of a market multiple of 15x on current S&P 500 prices to derive next year's earnings forecast) to estimate that the smart money is expecting a 35% reduction in sell-side estimates.

However, if earnings estimates get cut further than 35% because credit takes longer than anticipated to get restored, there could easily be more downside to stock prices from here. Then again, if estimates do not get cut to $60 but only $75 for 2009, my best guess is that will be very good for stock prices.

Earnings do matter, but they have not mattered much for the past several months. Still, I am a firm believer that investing in companies with solid business prospects that Wall Street misunderstands, produces superior investment results over time.

Because too much uncertainty remains in the market, we have been advising our clients to hunker down with a defensive posture until the turmoil in the credit markets abates. However, given the relentless selling that has occurred, many times without factoring in the true prospects and fundamentals of the underlying companies, one of the greatest buying opportunities of our lifetime could soon be right around the corner, and governments across the world seem to want to stop at nothing until that happens.

Why save the autos?

Farrell: The auto industry employs over 145,000 but the industry supports more than 600,000 retirees. If any of the auto companies were to go bankrupt, the repercussions would be several-fold. Massive unemployment would be the obvious first line of default.

There might be some credit defaults with the volume of auto loans that have been packaged, but I'm not sure that would be any different than what exists now. But I think the big issue lies with the retirees and the problem the government's pension guarantee program would have. If GM/Chrysler were to go belly-up, the pension guarantee program would be overwhelmed and in technical default.

Far cheaper to put $10 billion in the companies to keep them afloat than to take the hundreds of billions I think would be the result of a bankruptcy.

That is the line of thinking in my opinion. The pension guarantee shortfall is one of the dirty little secrets not talked about.

Carver: Vince et al., PBGC is somewhat like FDIC ... The entire program is based upon the public's confidence that their assets are backed--not by having the actual cash to back all banks (or pension programs). With this in mind, we will continue to see efforts on the government's part to maintain this confidence--for example, the temporary increase in FDIC.

Depending on your take with regard to entitlement programs, we will clearly need to see changes to the Medicaid program within the next three to five years.

This is really a different issue than a confidence issue since people's confidence, or lack thereof, does not affect the program like PBGC and FDIC, however, this appears to have become a right in most peoples minds rather than an "extra benefit," and therefore, in my opinion, the demand to shore up the program could divert assets from other areas. Just one of the interesting choices the new administration/Congress will be facing!

Farrell: In addition to bailing out the auto companies for a "mere" 10 billion or so to avoid the potential problem of defaulted pensions that could run to multiple tens of billions, I think "weaker" life insurance companies will be folded into bigger, better capitalized cousins with the help of federal investment.

The rationale for the government investing in the insurers ala the banks is to allow takeovers of sellers of variable annuity products that have been so popular with private investors. This is a guess on my part but better to make an investment in, say, MetLife so they can buy "XYZ" and probably a far cheaper way to provide support to the system.