That other Princeton economist

A "must read" Fortune interview with Princeton economist and NYT columnist Paul Krugman on the mortgage crisis at CNNMoney.com (hat tip to Calculated Risk). Krugman is considerably more pessimistic than many industry economists (and perhaps, his former colleague at Princeton, Ben Bernanke). Bullet points, bad news first.

Bad:

--Krugman sees home prices declining 25 percent overall -- much less in stable markets like Houston or Atlanta, but up to 40 percent to 50 percent in speculative markets like Miami and L.A. Just as home prices overshot on the way up, Krugman sees the potential for them to overshoot on the way down.

--By the time home prices are done falling, $6 trillion to $7 trillion in capital will have vanished, and 20 million homeowners will be upside down (owe more on their mortgage than their house is worth).

--The Fed may have to cut the federal funds overnight rate to zero. There's "a pretty good chance that we're heading to zero, and that there's going to be a Japan-style ZIRP, zero-interest-rate policy," he says. Meanwhile, "effective borrowing costs for a lot of people are rising, not falling," as mortgage rates haven't followed short-term interest rates down and many people who could borrow money two years ago can't.

--Assuming we are in a recession that began in January, it will take 30 months for employment to recover -- so July 2010 "is the first month we have anything that feels like a recovery," and the slowdown could drag into 2011.

--The increasing spread betwen LIBOR (the London interbank offered rate) and U.S. Treasurys "suggests banks are losing trust in each other." We are now experiencing the fourth wave of panic in credit markets in a year. "This is starting to look like a much more comprehensive financial crisis."

Good:

--There are no signs that we're headed for a return to 1970s style "stagflation" where prices rise during an ecnomic slowdown.

--The weak dollar is helping by allowing U.S. manufacturers boost exports. "Arguably the only good thing we have going for the U.S. economy now is the weak dollar and how that helps exports," Krugman says.

--There's still hope that Wall Street's troubles won't have a big impact on Main Street. While even the highest rated securities backed by subprime loans are trading at a fraction of their original values, "If all of the fancy financial instruments that have been so popular these past couple of decades sort of roll over, it's still not entirely clear to me how that ends up affecting the real economy."

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