n+1: We’re back in your office above midtown. Last time we looked out people were being fired, people were jumping out of windows . . .

HFM: And it’s continued largely in that vein. The credit crisis that was underway is still underway, and the recognition of losses is continuing—but it’s still continuing at a pace that means that the situation is not resolved. We haven’t reached a point where people feel like all the bad news is out of the way. It’s like a rainstorm of shoes: the shoes keep dropping, and there are still clouds in the sky, and there’s still going to be more shoes dropping, and until the footwear stops falling, you know, the crisis will continue.

n+1: You were optimistic that companies were announcing their losses, were dealing with the bad news. Was that not correct?

HFM: No, they are, they are, but people’s estimates of the size of those losses have increased. If you talk about subprime, most of those losses have been recognized. But the losses extend beyond subprime, they extend beyond leveraged loans. So now people are worried about prime mortgages, they’re worried about development loans, mortgages of commercial property, so the losses have not really been recognized, or the loss recognition process there is only just beginning. Then you have the whole issue of Fannie Mae and Freddie Mac: their equity is definitely wiped out, these things are insolvent, the equity has been burned through—you have negative equity. You have to recognize that. If you marked all their assets to market and said, “What are the assets worth?,” you’d find that the assets are worth less than their liabilities, which means that the equity is worth nothing. If that were a regular company—and not a company that plays this really important infrastructural role in the mortgage market—they’d go bankrupt. This company goes bankrupt. The equity should be wiped out and maybe some of the debt should be wiped out, and it needs to be restructured. But instead it’s like the zombies, they’re zombie companies. These companies are very politically powerful and also they’re important, and there’s fear that if they failed or if the equity holders were wiped out, it would lead to a horrible shock in confidence. But in the end, if you have a dead body in the room, and I keep saying, “That person’s not dead, that person’s just resting,” and pretty soon it starts to smell and decompose—there’s only so long we can pretend before the odor becomes overpowering and we have to run from the room.

n+1: And when we talked about whether this was going to spread beyond the credit market—that seems to be happening?

HFM: Well there are two kinds of linkages we can talk about in the ways the rot has spread. One is the financial linkages. So does it spread to other asset classes? And it has—there was a problem in subprime, and then it moved to Alt-A, and now people are worried about prime and commercial mortgages. So there definitely has been a financial spreading. The other linkage you worry about is, “Do the problems in the financial system spread to the real economy?” To a certain extent, obviously, right? The financial system is a way of accounting for what’s going on in the real economy. And so we see foreclosures, and unemployment ticking up and job loss, but I think people have actually been surprised at the extent to which the real economy has been stable in the face of all this. I mean, technically we don’t even have a recession yet! We haven’t had negative GDP growth! And that’s kind of a mystery. People in the financial community have been saying, “Gosh, things are so bad, pretty soon it’s got to spread to the real economy.” At a certain point if that recession never comes, then people will convince themselves that it’s not going to come. But right now, the fact that it hasn’t happened yet has not really changed anybody’s assessment in the financial world that that damage is still coming.