The U.S. Federal Reserve has taken some drastic steps in recent days to shore up the U.S. financial sector, including Tuesday's 75-basis-point interest rate cut.

There's a good reason for the moves.

Some economists think the conditions of today bear some resemblance to those before the 1929 stock market crash and the Great Depression of the 1930s.

"We are in the midst of the most pervasive financial crisis in a generation, which has destroyed untold sums of wealth in housing and financial assets and has driven the U.S. economy into recession," Sherry Cooper, chief economist of BMO Capital Markets, wrote in a commentary on Monday.

The late 1920s crisis had its roots in a stock market bubble popping. Some banks failed, in part because they had been playing the market. This led to people pulling their money out of banks because they feared the institutions would collapse, Laurence Booth, a professor at the University of Toronto's Rotman School of Business, told CTV.ca on Tuesday.

Some economists argue the U.S. Federal Reserve allowed a crisis to turn into a catastrophe by not supplying reserves to the banks that were facing a run on their deposits.

The current crisis is rooted in the meltdown of the U.S. subprime mortgage market and the current run on investment institutions, Booth said.

Essentially, many people got mortgages when in reality, they shouldn't have qualified. They put almost no money down and got low introductory rates which then skyrocketed after two years.

The mortgages only made sense in a constantly rising housing market. Homes in the U.S. became an "asset bubble" in part because the U.S. Federal Reserve slashed its key rate down to one per cent to help pull the U.S. out of the 2001 recession. Booth said the Fed left interest rates too low for too long.

When the housing bubble started to pop in late 2006, people holding those mortgages started to default.

This has affected financial institutions around the world, because these subprime mortgages were bundled and sold as investment securities.

Booth said this was possible because regulations stemming from the 1930s that separated investment banks from retail activities like mortgages were repealed in the late 1990s.

As a result of the "securitization" of bad mortgages, "you're seeing banks in Germany and France and Australia and all over the world (being affected). You didn't have that in previous times, so it's fairly unique," Don Drummond, chief economist of the TD Bank Financial Group, told CTV.ca on Tuesday.

American financial institutions exposed to these mortgages have had to take writedowns in the billions of dollars. CIBC in Canada has had to write off about $3 billion.

Credit crunch

This has led to a "credit crunch" in the United States that in turn triggered the collapse of the Bear Stearns investment bank -- the fifth largest in the U.S. and one that had survived the 1930s depression.

"A credit crunch is when banks themselves have difficulty getting funds," Drummond said.

In the U.S. today, "if you wanted to buy a house and you wanted even a conventional mortgage, you might not be able to get one because the banks themselves might not be able to get access to the funds," he said.

Booth said some people are even having problems getting their mortgages renewed.

One-third of U.S. banks say they've tightened up their real estate lending, Drummond said. "So that's a credit crunch; you just can't get credit."

Interest rate cuts "are irrelevant if no one will lend you the money," he said.

In normal times, financial institutions lend to each other, "but no one wants to lend to financial institutions at the moment because they're afraid they'll default on it and take them down," Drummond said.

As a result, the Bank of Canada, the Fed and other central banks are saying they'll do the lending in such situations, Drummond said.

That's where the phrase "liquidity," which is often tossed around on this issue, comes into play. "So a bank can't say, 'I don't have any funds to lend,'" he said.

The Fed essentially financed JPMorgan Chase's takeover of Bear Stearns. Cooper said the Bank of Canada will also act when needed.

"The Bank of Canada will not stand idly by. They joined the Fed last week in increasing credit provisions to the banks and will no doubt stand ready to act as lender of last resort in Canada," she wrote.

Drummond said a comparable credit crunch hasn't happened yet in Canada, but our "real economy" -- which produces goods and services -- is indirectly affected because 80 per cent of our exports go to the U.S.

And if you hold a mortgage here, mortgage rates have not been following the lead of the Bank of Canada's cuts in interest rates, he said.

Statistics Canada reported Tuesday that mortgage costs have been rising, even though overall inflation is down.

Cooper said the Fed has studied "depression prevention" and is trying to stop the "feedback loops" that could cause runs on financial institutions and lead to their collapse.

"In fact, (the institutions) don't even have to fail to affect the economy: They only have to see their capital impaired, or stretched, enough to shut down further lending. That could cause further economic weakness, which feeds back into greater stress on the institutions," she wrote.

Drummond thinks the U.S. economy is in recession and will stay in an "ugly economic scenario for quite an extended period of time" -- maybe until mid-2009.

He recommended that Canadian retail investors should re-examine their portfolios and not panic.

"The worst thing to do is sell out at the bottom," he said.