This is a rush transcript of "Special Report With Brit Hume" from August 15, 2007. This copy may not be in its final form and may be updated.

(BEGIN VIDEO CLIP)

ALEC YOUNG, INVESTMENT STRATEGIST: I think one of the issues in the market is there's a tremendous amount of uncertainty about how bad the liquidity crunch is going to get, where the bodies are buried, what's the next shoe to drop.

(END VIDEO CLIP)

CHRIS WALLACE, GUEST HOST: That's investment strategy Alec Young, and the uncertainty he's talking about is certainly an understatement given today's wild ride on Wall Street.

Time now to hear from our panel — Fred Barnes, executive editor of The Weekly Standard, Nina Easton, Washington bureau chief of Fortune Magazine, and syndicated columnist Charles Krauthammer, FOX News contributors all.

When we planned this segment earlier today, the stock market was down over 300 points. It was clearly in correction territory, which means it had dropped 10 percent from its high of 1400 points. It ended up down just 12 to 15 points. But Nina, as our resident market watcher, how low could this market go?

NINA EASTON, WASHINGTON BUREAU CHIEF, FORTUNE MAGAZINE: I think we're going to see it go lower, and then we are going to see it go higher. This is a snapshot of what we are going to see, and last week, as well, was a snapshot of what we're going to continue to see.

Treasury Secretary Hank Paulson told Fortune that he expects companies going under, investor losses. But he also says the economy's incredibly strong. And I think and the way to think about this is sort of like a big python that has swallowed a rat that's got to make its way through the system.

And that's what this sub-prime mortgage mess is all about. All these bad loans have to be marked to market, and it's going to take several months for it to work through the system.

So it's not a question of how low it's going to go. It's going to go low, high, low. It's going to make investors nervous. They don't like that unpredictability.

WALLACE: But Nina seems to be indicating, Charles that there could be a lot of pain along the way, both for the market, and also for a lot of companies that were involve in the sub-prime mortgage lending, and other companies that depend on credit markets.

CHARLES KRAUTHAMMER, SYNDICATED COLUMNIST: Absolutely. And the reason we have the wild rides, as we had today, is because you're not sure which companies.

Look, it's all a question of scale. Only 14 percent of mortgages are these sub-prime, and only about 3 percent are of those are in trouble. So overall, it's about $300 billion, which, relative to the size of the U.S. economy, the Japanese and western European, is a small amount.

But relative to the size of a company that could be holding this worthless paper, it could be huge. And the problem is you don't know which company. You don't know if a company in which you are invested, or a bank, or a hedge fund is holding a lot of this stuff.

But because it was packaged and distributed and marketed in ways that is quite obscure—and there are derivatives which are even more obscure. And the reason they are these panics on Wall Street is because people don't know if it's a bank that they're in, or a stock that they are in that is actually holding this stuff.

And there's no transparency, unlike in the Savings-and-Loan debacle in the 1990s (sic).

WALLACE: So, Fred, Treasury Secretary Paulson, who as Nina pointed out, giving a plug to Fortune Magazine, but also to the Wall Street Journal today, says, basically, that there could be real difficulties, that the market could slow U.S. growth, but, on the other hand, that the fundamentals of the economy are too strong to go into a recession.

Do you share his bottom-line confidence?

FRED BARNES, EXECUTIVE EDITOR, WEEKLY STANDARD: I think that's true now, but I haven't the slightest idea what the market's going to do tomorrow, any particular 15 minutes. I was watching it all day, and the shifts were incredible.

So this is a real problem. And it's a problem that the Federal Reserve has not been able to keep up with. And I think because they underestimated the panic that would set in, the problem of these sub-prime loans — which have been sold in packages of loans all over the world, in Asia, in Europe. So it's really a global problem.

And the Fed, really, and Ben Bernanke, the Fed chairman, his goal is obviously to stay ahead of the wave. Well, I don't think the fed quite has stayed ahead of the wave this week. I think they've ultimately dealt pretty well with the liquidity problem, but then there's a credit problem.

And Bernanke does not want to cut interest rates, but I think he's going to have to, to deal with the credit problem that is accompanying this liquidity problem.

EASTON: An, I was going to add, he doesn't want to reward risky practices by putting out there—

WALLACE: The lenders making bad loans, and the borrowers—

EASTON: —by lenders and the borrowers. And I think there's a lot of focus by Democrats, for example, on the lenders, but there are a lot of borrowers taking out loans that they shouldn't have.

But Bernanke doesn't want to be in a position of, basically, rewarding bad behavior, as it were. They took a pretty minimalist approach so far, adding liquidity to the market. I think that's what we're going to see.

You're also going to continue to see administration officials in their public statements walking this really fine line between acknowledging the bad news without feeding the bad news.

WALLACE: Charles, we've only got about 30 left in this segment, but where do you come down on the argument—Fred saying you've got to get ahead of this, you're going to have to lower interest rates, or the flip side, which is somewhat a philosophical argument, you shouldn't go in and reward, or bail out people that made decisions in the capitalist market that were bad?

KRAUTHAMMER: A crashing economy trumps philosophy.

If the wide effects of this spread, and it threatens innocent bystanders, essentially, the structure of the economic system, you have to go in and bail, as we did in the Savings-and-Loan, as we did in the post- 9/11 airlines and Chrysler.

It is a bad precedent, but every once in awhile you've got to have a bad precedent if there are external effects that are going to be disastrous.

WALLACE: All right, we've got to take a break here. But when we come back, the deadliest attack of the war in Iraq, and the growing battle here in Washington over the September Progress Report from General Petraeus. Back with all that in a moment.

(COMMERCIAL BREAK)

(BEGIN VIDEO CLIP)

COL STEPHEN TWITTY, MULTI-NATIONAL DIVISION-NORTH: I talked to one gentleman today that lost 29 members of their family. I talked to one the day before yesterday that lost 24.

(END VIDEO CLIP)

WALLACE: That was Colonel Stephen Twitty, who's heading up rescue efforts in northern Iraq, where coordinated truck bombs killed hundreds of people Tuesday.

And we're back now with our panel. So let's talk about this deadliest attack of the war on these small villages on the northern border of Iraq and Syria. Fred, estimates ranging from 250, now there's talk it might be as much as 400 or 500, what does this tell us about the enemy, both in terms of their tactics and also about their desire to have some impact on public opinion in this country?

BARNES: Well, it's clear they want to have some public opinion impact here, and they will, and they already have if you see the statements by Senate Majority Leader Harry Reid and others.

Now, what you have to stop and think is, why did al-Qaeda, why did they attack this particular group, this fringe Kurdish group, a minor sect, pre-Muslim, hated by Muslim extremists, in particular, because they think they're devil worshipers, why would they attack them on the fringe, on the border?

I mean, they're not in Baghdad, they're not in the city or anything? Because they're defenseless, basically, and al-Qaeda, and the other terrorists, know they can't attack Muslims anymore. They can't go blow up a hundred Muslims somewhere, because that's alienating Iraqis.

It's alienating the Sunnis, who now have joined with the U.S., and the Shia never did like them. And they have to pick on this particular group. This does not show the strength of al-Qaeda.

WALLACE: I was going to ask you about that, Nina. Isn't one of the other factors that with the surge hardening targets, making it harder to strike in a lot of other parts of the country, this was a soft target. This was still vulnerable.

EASTON: Right. And it also shows, I think, also just how everything is becoming much more complicated in this scenario, as the Petraeus report, which is coming up on September 15, it's going to show all these complications—the Sunnis turning against al-Qaeda, some progress in areas such as Baghdad, these kinds of bombings going on in soft target areas.

And I think it's going to be a more difficult—when this report comes out, it's going to be a very difficult case for the Democrats, in particular, to be clear about whether there is this surge is working or not working.

WALLACE: Charles, let's talk about the Petraeus report, because we in Washington woke up this morning to a Washington Post front-page story that indicated that when the report from General Petraeus comes out in mid- September, that the people who are going to be testifying about it in public were going to be Secretary of State Rice, Secretary of Defense Gates, but not General Petraeus.

The White House very quickly said, not so. General Petraeus is going to testify in public, and in private. What do you make of this controversy, and wouldn't it have been stupid PR for the White House not to put out the man who's got the most credibility in Washington now, David Petraeus?

KRAUTHAMMER: Well, that's why it was an odd story, and I did call the White House when I saw it, because it does not make sense. The one spokesman on behalf of our effort in Iraq who is a credible one, and a new one, is Petraeus. Why would you not have him over there?

In fact, I called the White House, and one spokesman said to me, of course we want him out there, regardless — if we could have him on "Oprah," we'd love that. A rather arresting image, don't you think?

Of course he's the man that you want out there. And also, under the legislation, he's required to give a public report. There was a dispute over whether he's going to write the report or not. But again, under the law, it's the president as Commander in Chief who submits the report, and, obviously, the input he gets is from his commanders on the ground.

WALLACE: The interesting thing about this—

BARNES: I'm not sure it's a real story. I talked to once of the principals who was going to be a substitute for Petraeus who didn't seem to know—was planning on Petraeus testifying, and this was as recently as yesterday.

WALLACE: Let me ask you about that, Fred, because you were talking about Harry Reid earlier. Despite the White House denials—"No, Petraeus is going to testify," Senator Reid, the Democratic leader, refused to take "yes" for an answer. Let's put up the statement that he made.

He said "It appears to be yet another politically driven attempt to avoid giving Congress and the American people an honest and open assessment of a war we can all see as headed in the direction."

Fred, what's the line from "Alice in Wonderland," sentence today, verdict afterwards?

BARNES: Yes. Look, it's in the legislation—Petraeus has to testify in public and in private. And, look, how could President Bush go around— he mentions Petraeus a dozen times every day, about how he's going to come and give his report in public.

I don't believe the White House really tried to do this. In fact, I had heard that some Democrats were wary of Petraeus testifying in public.

EASTON: I was just going to say, to some extent, this is going to take the wind out of the sail of critics, because if he's talking about responsible redeployment, that's going to be very much like what we're hearing from the critics.

WALLACE: That's it for the panel.

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