Dow Down 500: It Could Have Been Worse, But 'Crash' Risk Remains, Roubini says

As shares of Wall Street titans Lehman Brothers, Bank of America and AIG plummeted, the Dow tumbled over 500 points Monday while the S&P suffered its worst decline since 9/11.

The decline was certainly dramatic and painful for those long, but it was not as bad as the "Black Monday" many market participants expected heading into the session. Still, a 1987-like crash cannot be ruled out and investors should take steps such as buying puts to protect themselves against such a "fat-tail event," says Nouriel Roubini, economic professor at NYU's Stern School and chairman of RGE Monitor.

Roubini says Monday's decline could have been worse if not for a series of "new dams" created this weekend and Monday, including:

• The Fed's expansion of its lending facilities for financial firms.
• Raised expectations for a Fed rate cut at Tuesday's previously scheduled policy meeting.
• The Bank of America deal to acquire Merrill Lynch, discussed in detail here.
• The $70 billion "liquidity fund" created by a consortium of banks.
• Discussion of a separate fund to aid AIG, whose shares fell 61% Monday. 

But nothing has changed Roubini's baseline forecast for another 20% drop in the stock market. The economist, who has been eerily prescient in predicting the ongoing crisis, recommends investors avoid risky assets, including commodities as fears of a global slowdown take hold. On Monday, gold benefited from a "flight to safety" trade in the wake of Lehman's bankruptcy, but oil fell to its lowest level since mid-February.

Meanwhile, NY Post reporter Mark DeCambre notes major Asian markets were closed Monday for holidays. "We could be looking at two days of carnage," he says, when Wall Street reacts tomorrow to the delayed reaction in (most notably) Japan, China and South Korea to Monday's slide and this weekend's drama.

The drama included a special trading session for counterparties to Lehman. As bad as Monday was for the stock market it was much worse in the market for credit default swaps, a somewhat arcane market that is at the epicenter of a great debt unwinding that may just be getting started. (Click here for a discussion of what the coming credit contraction means for consumers and the economy at large.)