A couple of points.

What is going on as of now is considered a massive correction. After 911, the stock market sunk to a low of 7,300 points due to investor/ consumer confidence being rattled. Generally when this happens, prices begin to fall in an effort to regain sales figures, or at least move inventories out of lock due to the psychological effects of economic fear. This is referred to as market deflation, as prices were too high given the specific economic circumstances. Most of the time, deflation is bad for middle class Americans because as prices generally fall, so do wages. For example, if a farmer was making $100,000 a year off his crop, and a period of deflation occurs the following year, say raising the buying power of a dollar by 10%, that would equate to the farmer only getting $90,000 for his crop the following year. Of course, when he buys anything such as fuel, machinery, or whatever, he needs less dollars to purchase the same goods only one year ago. Many people might see this as a good thing, as the cost of gas is down. On the flip side, as many of you can attest, there are many fixed costs associated in life as well as business. If the farmer were to have a mortgage payment on the property, it will not fluctuate in accordance to deflation. Same goes for any big ticket purchases bought on credit. The value of the items the farmer has financed will also drop in accordance, even though he is still on the original nominal value associated with that good. Governmental solution is to provide easy credit to speed up the economy, because inflation is less of a concern than negative GDP growth.

What this shows us is that even if your buying power increases, your wealth is actually decreasing. This is exactly what happened in the housing market. Easy credit made it easier for loans to be issued. One of the main reasons for the demand for new money was in fact rising fuel prices. If the cost of fuel is increasing by 50 %, the money supply will have to fluctuate in accordance to the increased dollar demand of fuel. Instead of the money being used to spurn actual growth, people were buying houses, and the home builders industry was growing at an artificial rate. To top it off, lenders were leveraging collateral accounts in the range of 40:1; mortgage brokers also work on a volume commission, where they get bonuses for an increase of transactions. Therefore way to much money was flowing into the housing market creating a bubble that would eventually pop.

As sub prime home owners teaser rates stopped, and interest rates went back up as inflation fears became a target, mortgage payments on the whole increased. Foreclosures soon followed, which in turn lower the property value of the surrounding areas. Deflation roars its ugly head again as housing values dropped as much as 70% in some areas, even in non sub prime homes. What you had essentially were people making payments on a note valued at lets say $500,000, but the current value of their property was only $150,000. Then add the increased cost of fuel, and the increased costs of transportation of goods due to the rise in fuel prices and you have a situation where peoples overall wealth was diminishing.

As the defaults increased, the leveraged securities had to pay the piper, and the firms that were now responsible, for the remaining leveredge that would eventually cripple the ability to finance. No financing equals a drastic cut in sales (see GM), and forces firms to downsize by way of layoffs (cyclical unemployment).

Stock prices then tumble downward, as people cash out in hordes due to fear of loss.
------------------------------------------------------------------------

This has the potential to be very bad, but those who are calling this a depression need to use history as a tool.

When the Dow finished falling following the '29 panic, it dropped from the 330's to 41 points. The current equivilant would be the Dow around 1,500 points.