EDITOR’S NOTE: Liz Peek is a financial columnist.

“Attention, Shoppers! Please keep spending! Don’t worry about your slumping home price, the climbing price of gasoline, the scary stock market. We’re counting on you!”

Rather than engineering the bail-out of large investment banks, maybe Treasury Secretary Paulson should be issuing messages like the one above. After all, the crisis of confidence, which is gumming up the credit markets and which almost flung venerable Bear Stearns into bankruptcy, is now infecting the consumer, as shown by the stall in February spending announced today.

What, really, is at the heart of today’s economic slowdown, and the dramatic ups and down in stock prices? There are many problems, but the main answer is that investors, bankers and policy makers are still unsure about the extent of the so-called “subprime contagion”. Climbing defaults among those with weak credit who bought homes in recent years have infected many classes of securities built on those mortgages. Those debt instruments were layered (often with lots of leverage) into veritable investment napoleons and then sold all over the world to banks, hedge funds and other institutions. The buyers had no idea that at the heart of these complicated securities, which were often triple-A rated, there lurked very fragile subprime mortgages.

So we have great uncertainty, especially among financial institutions. Many have taken substantial write-downs of these assets, damaging their credit and worrying investors. Further charges are expected, and the estimates vary wildly. Andy Davidson, who specializes in risk analysis in the mortgage-backed securities business (and whose phone has been ringing off the hook for six months), told me last summer, “We have 10,000 financial institutions in this country and we know a few will go broke; the problem is we don’t know which ones they are.”

Shaken by these issues, bankers are not lending, despite massive infusions of liquidity engineered by the Federal Reserve. This is hurting small and medium size businesses and also causing the collapse of large deals such as the $19 billion buyout of Clear Channel, which has been in the news lately.

Fed Chairman Ben Bernanke and Secretary Paulson are doing their utmost to be sure that no big banks or investment banks go bust. This has angered those who object to the government “bailing out” the speculators who got us into this fix. The truth is that the failure of any large financial institution would be like a large ocean liner going down; it could suck any number of smaller vessels down along with it.

When will we hit bottom? I think a recovery has to start in the real estate markets, where the problems originated. Recent headlines on the housing front have been dramatic. Builders of new homes have slashed prices by more than 11 percent and have cut new home starts by half. Inventories of new homes for sale have dropped sharply. Prices of existing houses are down more than 13 percent from the peak. Mortgage rates have fallen too. This will help.

Still, a recovery in housing is probably at least a year away. Price declines on new homes appear to be slowing, but top economic firm ISI points out that in the 1990s real estate slump prices on new houses bottomed more than a year ahead of prices on existing homes.

Once real estate markets begin to stabilize, homeowners will be less tempted to walk away from their mortgages. As a result, the credit markets will begin to recover as lenders will have a better fix on their exposure to the subprime meltdown. Eventually, the banks will begin to lend again, spurring growth forward.

The markets will anticipate this turnaround. Some say the market has already hit its low point, when the Dow touched 11,600 in late January. I hope that’s true, but I expect that the recovery will be muted. This market scare will not soon be forgotten.