Mark Zandi
Co-founder and chief economist of Moody's Economy.com

Zandi directs the research and consulting activities of a company that provides those services to businesses, governments and other institutions. His recent research includes mortgage foreclosures, tax and government spending policies and an assessment of policy responses to bubbles in asset markets. Zandi recently spoke with Judith Schoolman about today's economic climate.

Q: Your forecasting philosophy employs four key elements: data, models, market insight and experience. With all the turbulence, how does this philosophy stand up and what do investors need to know now?

A: Forecasting is certainly challenging in the midst of the current financial crisis. Models are built on historical relationships, but current events are without precedent. However, it's important to note that each financial crisis we have faced in our history has come to an end when the government steps in aggressively to stem the crisis. The government's response to recent events has been very aggressive and creative, ranging from the takeover of Fannie and Freddie, to setting up an insurance fund for the money market mutual fund industry, suggesting that we are at the beginning of the end of this crisis. Investors will struggle with disappointing returns well into next year, but this is better than the negative returns many have struggled with over the past year.

Q: In your book "Financial Shock," you write that the subprime mortgage crisis—which you say has led to one of the most devastating global economic disasters in history—was an accident waiting to happen. What's the way out?

A: The current financial crisis will only come to an end when it is clear that the financial system has taken all of the losses on the bad mortgage loans that were made during the housing boom. Some 15 million very sketchy loans-subprime, alt-A, and jumbo option ARM loans-were made during the boom, the majority of which will eventually default and end up as a loss to the financial system. Financial institutions have taken losses of well over $600 billion on these loans. Government can help by establishing a market for these loans so that it can be determined whether more losses need to be taken. But I think most of the worst of this financial crisis is behind us. The most at-risk large financial institutions have failed from Bear Stearns to Washington Mutual. There will be other failures, which may include another large institution or two, but most of the failures will be among smaller depository institutions.

Q: How can investors protect themselves from more financial shocks to come?

A:The key is to remain well diversified. If an asset is rising quickly in price and its value is becoming an increasing share of your investment portfolio, it is probably time to think about reducing your holdings of that asset. The more quickly and higher prices rise for an asset, the quicker investors should diversify away from it. Investors must do their own due diligence and not take anyone else's opinion as a given. If you do not understand how the instrument works and the risks involved, it is probably not something you want to invest in.

Q: When the U.S. gets its financial act together, what can be done about problems overseas?

A: The more closely integrated our economy and financial system become with the rest of the world, the more the global financial system will operate under the same accounting, regulatory and legal framework. U.S. policymakers should facilitate this integration so that everyone is operating with the same information and under the same rules.

Q: On The Dismal Scientist website, you discuss how investors are fleeing from risky investments. Gold prices are skyrocketing. Is this a time to put money under the mattress, so to speak?

A: No, just the opposite. If history is any guide, then it is when everyone is panicking that's the time when very profitable investments can be made.