Of course, the Fed did increase interest rates from 1 percent in 2004 to 5.25 percent in 2006, but that was more about normalizing interest rates after an extended low-rate regime. Monetary policy never got too tight in the United States, and inflation has not been a serious problem in the present cycle. As a result, the Fed is now in a good position to aggressively cut interest rates. In the past credit crunches, including the savings-and-loan crisis in the late 1980s, inflation concerns prevented the Fed from being more proactive.

More important, apart from the troubles in the financial sector, U.S. corporations are in fairly good health. Profit margins are close to record highs, and investment levels are in line with historical norms. U.S. firms did not succumb to overspending during this business cycle, as scars from the 2001–02 recession were still raw. Inventories are also at fairly lean levels as businesses have been paring back on their stock since the middle of last year given all the well-advertised warnings about the coming slowdown.

During recessions, payrolls decline by a massive 215,000 heads a month; at present, however, modest increases are still underway. If companies do not feel the pressure to layoff workers and income growth keeps rising moderately, the consumer will retain enough of a cushion to weather the turmoil. It is important to remember that unlike corporations, consumers don't change their behavior overnight. Consumers make gradual changes to their lifestyles, and while it's almost certain that there will be a downshift in spending habits in response to the housing-market shock and tougher financial conditions, any abrupt change seems unlikely.

Chances are that what we'll see instead is many quarters—if not years—of subpar growth in the U.S. economy, not a dramatic downturn, as both the consumer and the financial sector gradually rebuild their balance sheets with ample help from policymakers. The negative effects of credit crises tend to linger for years, since the bias of a democratic system is to amortize the pain over time rather than swallow it in one shot.

This may not be the most desirable outcome to the purists who would rather see all problems liquidated immediately. But for investors facing storm clouds in the markets today, any outcome short of a full-fledged recession will feel like early spring after a winter of discontent.

Sharma is head of global emerging markets for Morgan Stanley Investment Management.

© 2008