What started in subprime is likely to continue cascading into the markets and keep the economy down until 2010, economist Paul Krugman forecasts. Bottom line for homeowners: An average drop of 25%.

If there is any word that captures the mood in the economy right now, it's uncertainty, along with shadings of bafflement and distrust. We have never seen a credit crisis quite like this. What's next?

Princeton economist Paul Krugman spoke with Fortune's Jia Lynn Yang about the impact on the economy, the outlook for home prices, and the reasons for both fear and hope. Krugman, a former Fortune columnist who now writes a column for the New York Times, will also appear in a one-hour CNN & Fortune special report on the economy that premieres March 28 at 8 p.m. ET.

Fortune: By year-end, 15 million Americans could have mortgages worth more than the value of their homes. What happens then?

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Krugman: Actually, I think home prices will fall enough for us to produce about 20 million people with negative equity. That's almost a quarter of U.S. homes. If home prices are rising, or if there's positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We're probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there'll be $1 trillion of losses on mortgage-backed securities showing up somewhere.

How far do you think home prices will fall?

My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We'll probably basically retrace all that. So that's about a 25% decline in overall home prices. Only a fraction of that's happened so far. Of course, it varies a lot. In places like Houston or Atlanta, where home prices have not risen much compared with underlying rents, the decline will be relatively small. In places like Miami or Los Angeles, you could be looking at 40% or 50% declines.

Is there a risk of a spiral too, where the more homes that are foreclosed on, the lower home prices go?

Not without limit. But if we think home prices overshot on the way up, why can't they overshoot on the way down too? And to the extent that this all produces a recession, that's also bad for housing demand. People at the Fed are talking about feedback loops. At the moment, most of what they're concerned about is that falling home prices are leading to a credit crunch, which is actually driving up mortgage rates and making mortgages unavailable, which is causing home prices to fall even more. I'm not one of those people who thinks the Great Depression is coming back, but there's lots of echoes.

Why not the Great Depression?

Because I think we know something that we didn't then. The Federal Reserve was clueless back then. They were only concerned about protecting the nation's gold reserves, and the federal government believed that austerity and cutting spending was the answer to recession. I think we know more than we did then, and just the fact that we have a big federal government is a stabilizing factor. But the current problem is still pretty awesome.

Can you compare this to other economic crises the U.S. has faced?

The financial stuff looks like a combination of 1990 and 2001, and probably bigger than both combined. You've got the financial disruption, which is probably bigger than the savings and loan crisis. And you've got the loss of wealth from the housing bust, which is bigger than the dot-com bust. So this looks fairly nasty. And then everybody who's paying attention is worrying about the Japan analogy. Japan never had a really severe recession. It just started with a recession and never really had a recovery for a whole decade. And that's the kind of thing we're afraid of.

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