“What’s the capital of Iceland?”

“Oh...about $6.50.”

That’s the joke that is making its way around London this morning.

Iceland has melted down. Now, the government has pledged to save the banking sector – but at a cost of nearly $500,000 per citizen! In Europe, the cost so far is estimated at about $7,000 per citizen. But experts insist that much of that money – loaned to the banks – will come back to the government.

And in America? Who knows...?

The subject is on every pair of lips. It has replaced the weather as the focus of casual conversation.

“How ‘bout what is going on at the banks,” say farmers to one another.

And on the radio, talk shows are alive with recriminations, conspiracies and finger pointing. The man on the street is like a palm tree in a hurricane, wondering what makes the wind blow so hard.

On Monday, the wind shifted. The Dow shot up – along with the rest of the world’s stock markets. People looked up and saw sunshine. But was it a genuine end to the storm...or just the eye of the hurricane that was passing over?

Then, yesterday, the clouds came back. The feds announced that they had to force an evacuation. Capitalism would have to leave town – at least temporarily. They partly nationalized nine U.S. banks.

The Financial Times recorded the scene at the Treasury Department as they told the world:

“America is a strong nation. We are a confident and optimistic people,” declared Hank Paulson, Treasury secretary.

“Our confidence is born out of our long history of meeting every challenge we face.” But then reality reared its ugly head. “There is a lack of confidence in our financial system...it poses an enormous threat to our economy. Investors are unwilling to lend to banks, and healthy banks are unwilling to lend to each other.”

So was America confident or terrified? Apparently, it was confident that it could stop being terrified – but only if the government came to the rescue.

Deputy undertaker Ben Bernanke, Federal Reserve chairman, stared grimly into space; Sheila Bair, head of the Federal Deposit Insurance Corporation, nodded occasionally. Tim Geithner, president of the New York Fed, stood with both hands in his pockets, looking concerned.

Mr. Bernanke’s turn came next, promising to do whatever it took to save the nation from disaster while letting slip that even yesterday’s giant intervention might not be enough. Then up strode Ms. Bair, her head barely visible above the podium Mr. Paulson had towered over, to detail the “extraordinary steps” the government was taking to save its banks.

Saving the economy would require “a sustained and coordinated effort by government authorities”. People may have lost faith in the private sector but not the power of federal authorities to rescue them. “Above all else, there must be no doubt in our government.”

Ronald Reagan must be turning in his grave, the FT concluded.

But the deed was done with hardly a peep of complaint. Those few who were inclined to peep were pushed aside and ignore.

The Dow fell 76 points yesterday – a bad sign. Usually, following such a bad week, you’d expect the dead cat to bounce for several days. This one had a good bounce on Monday and then lay as still and as silent as a tax collector’s tomb.

This is an ‘emergency;’ everybody says so. All very well to take the high road when the weather is fine. But when storms come, people look for shelter wherever they can find it.

How bad will the storm get? This from Nouriel Roubini, Professor of Economics at the NYU Stern School of Business:

“The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity where excessive leveraging and bubbles were not limited to housing in the U.S. but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.

“At this point the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the U.S. and advanced economies contraction would be short and shallow – a V-shaped six month recession – has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the U.S. and close to two years in most of the rest of the world. And given the rising risk of a global systemic financial meltdown, the probability that the outcome could become a decade long L-shaped recession – like the one experienced by Japan after the bursting of its real estate and equity bubble – cannot be ruled out.

“At this point the risk of an imminent stock market crash – like the one-day collapse of 20% plus in U.S. stock prices in 1987 – cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.

“A vicious circle of deleveraging, asset collapses, margin calls, and cascading falls in asset prices well below falling fundamentals, and panic is now underway.”

And, looking in our old book, Financial Reckoning Day , written with Addison Wiggin, we find this remarkable forecast:

“If the US were to repeat the Japanese experience, stocks would be expected to return to their 1995 trend line, with the Dow below 4,000 in the year 2012, at the very moment when America’s baby boomers will most need their money.”

Get out your galoshes.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.