Since September 1, the S&P 500 Index has now crashed a cumulative 39% -- the worst decline since 1931 for common stocks in the United States. The MSCI World Index over the same span has been pummeled more than 45% -- its worst year since 1974. The latter benchmark was created by Morgan Stanley back in 1969. There isn’t one index in the world that has posted a gain in a miserable 2008.

Declines of this magnitude in a short period of time have probably destroyed more wealth worldwide since the Great Depression.

Spectacular Loss of Wealth

This bear market is clearly in the record books with stocks defying the average 30% bear market decline at this point and combined with the ongoing breakdown of credit markets, is far worse than anything anyone alive has ever witnessed. In all likelihood, the current generation of investors will not return to the stock market for a long time, if ever.

Over $6 trillion dollars of stock and bond market wealth has literally evaporated globally this year. Combined with huge losses recorded in real estate, mortgage-backed derivatives, credit default swaps and leveraged loans, the figure is probably well north of $10 trillion dollars thus far.

Auto Industry, TARP Uncertainty

With the auto industry now the bailout “flavor of the month” in November, investors are fretting over the possible demise of one or, possibly, all three U.S. automobile manufacturers. The Big Three have seen their respective stock prices almost disintegrate this year with GM trading at the same nominal price it did during the Great Depression.

Conservatives in Washington are balking at an auto industry bailout and investors are worried that any delay in helping Detroit will result in the collapse of the industry, hundreds of thousands of jobs and the long chain of suppliers tied to the ailing auto sector.

Chrysler, General Motors (GM) and Ford don’t deserve a bailout; all three companies have bled billions of dollars in cumulative losses over the last 25 years and a rescue will only postpone the inevitable – bankruptcy.

Combined with Treasury Secretary Hank Paulson’s reversal on TARP (Troubled Asset Relief Program) last week, the stage for another market crash has arrived again this month as stocks threaten to violate the October 2002 lows. The Dow Jones Industrials Average bottomed in October 2002 at 7,286 or just 267 points below Thursday’s close.

Paulson doesn’t want to create a special SIV or Structured Investment Vehicle to pool toxic mortgage-backed securities after all. Now the Treasury wants to keep its powder dry with the remaining $400 billion dollars of the initial $700 billion in TARP funds to bailout any other systemic threats to the American economy.

Instead of dealing with the problem, which is largely a spectacular lack of counter-party confidence among banks, Paulson is extending the bear market.

Banks Need to Dispose Toxic Assets

Paulson, in my opinion, is making a big mistake. The government should create a special fund or company dedicated strictly to buying troubled or illiquid bank assets.

In the absence of such a plan – originally cheered by investors last month – the markets have no grasp as to which banks hold clogged assets, ultimately delaying the cleansing process for badly damaged bank balance sheets. Confidence won’t return to counter-parties until banks or lending parties fully understand what other institutions continue to hold on their balance sheets.

The Battle against Deflation

The only dose of positive economic news lately is that Hewlett-Packard reported solid third quarter earnings – largely the result of aggressive cost-cutting. Yet this news didn’t help the market, either. Unemployment claims hit 1982 levels for the latest period reported on November 20 and more companies are warning of weaker revenues in 2009.

Wholesale inflation and the consumer price index plunged in October as commodity prices tanked. Since peaking at $147 a barrel in July, crude oil prices have plunged 67%. Other commodities have also crashed, including the grains, base metals and the precious metals. Commodities have collapsed at exactly the same time demand for goods have fallen of a cliff.

Deflation, not inflation, is now a war the Federal Reserve and other central banks must win in order to safeguard the financial system from total collapse. At this point, investor capitulation seems to be near with massive selling engulfing the markets since November 5 and Treasury bond yields at multi-year or multi-decade lows.

One way to restore investor confidence is to finally let Detroit die a quick death. The industry is a lousy business model and propping-up bad companies with good taxpayer’s money is a total waste. The resultant demise of Detroit’s biggest industry would be painful but supporting these money-losing enterprises is the wrong policy. We all know more money will be required in six months, a year, whenever.

Let the Big Three crash and revive TARP’s original mandate by removing the uncertainty plaguing bank balance sheets.