The review frequently begins by taking stock of the factors typically precluding a sharp decline in financial markets: low inflation and low interest rates, highly liquid balance sheets and financial markets, excessive lending and risk taking, rising house prices and public debt, as well as a sense of euphoria. And throughout this century and the last, once the dust settles, it’s the usual modus operandi: People label the crisis as “the worst since 1929,” central banks intervene and regulation talk starts to heat up. But, as investors try to weather the declines, problems begin brewing elsewhere, often going unnoticed until they emerge as the next financial crisis.

Not a pretty picture, but one painted by many a market scholar, including Franklin Allen, professor of finance at The Wharton School at the University of Pennsylvania. Allen and Professor Douglas Gale of New York University co-authored the 2007 book Understanding Financial Crises. Allen believes the subprime woes can be traced back to US tax law and the Fed, the very organ now responsible for fixing the problem. According to US tax law, interest is tax deductible and rent is not – an incentive to home ownership or, conversely, a penalty to renting. By providing too much liquidity and holding interest rates too low for too long, the Fed caused a bubble in property prices. Money was readily available and consumers responded by taking out mortgages for 100% of the value of their homes and writing off the interest. Everything was fine until property prices began to decline.

The ongoing subprime crisis has many parallels to the late 1980s Japanese asset price bubble. As Allen explains, “Japan had a much more extreme version of it, but they had property prices and stock prices driven to very high levels in the 1980s because interest rates were too low … Then they got concerned about inflation and raised interest rates. And that’s what caused the huge problems. The property prices in Japan fell 70% to 75% over 15 years and it stopped the economy growing. And they still aren’t out of it. Interest rates are at very low levels. They haven’t grown like they did in the ’60s, ’70s and ’80s.” For Allen, with the exception of inflation, the situation in the United States is eerily similar.

“Rising inflation makes life very difficult for the Fed. They cut interest rates and they expected that inflation would just go away, but it hasn’t. If the Fed tries to combat rising inflation by raising interest rates, they risk a worse situation with the financial sector. In terms of the extent of the bubble, I’d be surprised if property prices fell 70%. In July, they were down about 16%. In Japan, 20 years after the crisis, the stock market’s value is less than a third of what it was in 1989. I don’t think it will get that bad in the United States, but it may get a lot worse in terms of unemployment and social problems. Japan didn’t do so bad in the social dimension,” says Allen.

During Japan’s so-called “lost decade,” problems in the banking sector spilled over into the real economy, just as it is doing in the United States right now. After years of experiencing growth rates among the highest in the world, the country became one of the world’s slowest-growing.

So, how bad will it get in the United States? Allen cites figures corresponding to average economic downturns following financial crisis over the last 120 years. These lasted two to three years and cost 5% to 10% of the GDP. “There is huge uncertainty out there. I wouldn’t place much weight on what the official bodies say could happen. They have been consistently wrong. Anything can happen, such as a run on the dollar or the declaration of banking holidays,” says Allen.

George Soros can also imagine a run on the dollar and says its days as the world’s reserve currency are nearing their end. But Soros has a slightly different explanation of the subprime crisis than Allen does. In his latest book, The New Paradigm for Financial Markets, the billionaire investor and philanthropist argues that problems with subprime mortgages pricked an even larger bubble: a super-bubble caused by globalization, deregulation and credit expansion. But no cause for worry, Soros argues. The icon of investors believes there is enough economic global power, and so urges people to be optimistic. He writes, “There is no reason to expect a global recession. Powerful expansionary forces are at work in other parts of the world, and they may well counterbalance a recession in the United States and a slowdown in Europe and Japan.”