The Persistent Credit Crunch

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"We've only begun to see the pain for the homeowner," Gross said. He expects the Federal Reserve, which already has lowered interest rates 0.75 points, to lower its federal funds rate, now at 4.5%, to 3.5% by the time the crisis is over.

Foreclosures Still Mounting

The big worry, say Gross and others, is home values. The overheated real estate market already created a housing bubble, pushing prices to unsustainable levels. Now, with subprime mortgage defaults, experts expect a wave of foreclosed homes to go up for sale at bargain prices. An analysis by Bear Stearns (BSC) says annual foreclosures could reach 1.8 million by the end of 2008, up from an average of 660,000 before 2006.

The result of all this foreclosure-driven supply? "Total home-price declines in the 15% to 20% range are not unreasonable in a scenario of disorderly liquidation," wrote Dale Westhoff, head of mortgage-backed securities fixed-income research at Bear Stearns.

The Fed will likely do everything it can to prevent such a scenario. "The Fed can't afford to let home values fall 10% to 15%," Gross said, mostly because of the devastating effects on the economy. Federal Reserve Chairman Ben Bernanke testifies before Congress on Nov. 8. He's likely to be grilled about what can be down to slow housing's slide or prevent an economic slowdown.

A Grim Outlook

Credit market worries aren't likely to end soon. The first problem, says Avery Shenfeld, senior economist at CIBC World Markets (CM), is all the uncertainty. Every day more rumors appear about another major financial institution in trouble. "The markets may calm down once the unknown is better known," Shenfeld says. He thinks this may happen in the next couple of months, as the end of the year gives financial institutions a chance to come clean about their subprime exposure.

Second, the markets may need some reassurance that the fundamental problem—worries about mortgage debt and falling housing prices—have stabilized. "The first sign that a broader healing is happening would be…some stability in home prices," McCarthy says. However, he adds, "There are really no encouraging signs on that point."

Cabot's Larkin thinks the government may need to help troubled borrowers stay in their homes. But any such move would take months, if not years, to show effects, and no one in authority has proposed such an ambitious effort yet.

For many investors, whatever light was visible at the end of the credit-crunch tunnel appears to have dimmed drastically, adding one more big worry for Wall Street in the months ahead.

Steverman is a reporter for BusinessWeek's Investing channel.