This is a rush transcript from "The Journal Editorial Report," December 29, 2007.

PAUL GIGOT, HOST: This week on the "Journal Editorial Report," the biggest stories of 2007 and the one sure to make headlines in 2008. From the turn around in Iraq to Europe's turn toward America, a look at the events that shaped the past year.

Plus, will the Obama bubble burst?

And will Fidel Castro finally step aside?

Our panel has their predictions for the year. It's all coming up on a special edition of the "Journal Editorial Report".

(NEWSBREAK)

GIGOT: Welcome to the "Journal Editorial Report." I'm Paul Gigot.

From the success of the Iraq surge to the subprime morality meltdown it was another remarkable year. And this week we will look down at those sure to make headlines in 2008. We begin with the biggest stories of this year.

Joining the panel this week, "Wall Street Journal" colonist and deputy editor Dan Henninger, foreign affairs columnist Bret Stephens, and editorial board members Dorothy Rabinowitz and Mary Anastasia O'Grady.

Dan, what's your biggest story or trend of the year?

DAN HENNINGER, COLUMNIST & DEPUTY EDITOR: My biggest story was the meltdown in the subprime mortgage market. I call this the greatest example of moral hazard in the history of the world. What is moral hazard? It means when you reduce risk to a low point people behave irresponsibly. The irresponsibility here is unbelievable. We now believe maybe 50 percent of the mortgages were fraudulent in some regions of the country.

The risk management controls that many investment banks and investors had applied to these securities they marketed, were almost nonexistent. Merrill Lynch, USB, Citigroup, they are taking tremendous hits from this.

GIGOT: We in journalism assign blame. We do that are a living. How about the Federal Reserve and the people in Washington who encouraged housing? They said we want home ownership to be 70 percent, 75 percent, 80 percent. Now when people over lend, now they go around blaming people for having made these loans. And the Federal Reserve had easy money, way too easy money.

MARY ANASTASIA O'GRADY, EDITORIAL BOARD MEMBER: Isn't the reluctance of the Federal government to let people take their lumps right now? Just add to the problem? It seems to me we haven't learned anything from this.

HENNINGER: My God, the Paulson Plan is thinking about freezing teaser rates for five years. What if they are freezing teaser rates for criminals?

GIGOT: How long will this last, Mary?

O'GRADY: I think the housing market will be in the doldrums for most of next year. But it is not a big part of the U.S. economy. It doesn't have to damage the whole U.S. economy but it won't come back any time soon.

GIGOT: Mary, what is your big story or trend of 2007.

O'GRADY: My big story is the resilience of the U.S. economy.

GIGOT: The flip side of Henninger.

O'GRADY: Well, Dan has just told us...

GIGOT: Mr. Gloom.

O'GRADY: Dan, has just told us -- and Mary sunshine.

GIGOT: I won't go that far.

GIGOT: Dan has just explained to us about the subprime debacle. We have soaring energy prices, commodity prices and have been at war for four years. If you could talk down the U.S. economy, we would be in the dumps now because Alan Greenspan, as early as February, told us we were heading for recession. And yet we are going to have probably on the year, a better than 2.5 percent growth and we have unemployment below 5 percent and the economy created 300,000 new jobs a month on average the last three months. That's a very resilient economy.

GIGOT: Do we have a bear in the midst here? Anybody who wants to predict something worse.

BRET STEPHENS, FOREIGN AFFAIRS COLUMNIST: I think someone ought to pay attention to what is happening to the dollar. I was talking to a friend of mine just back from Russia where even Russian cab drivers mock the U.S. dollar and are only taking euros.

GIGOT: Another convention of the Federal Reserve policy that hasn't paid attention to the value of the dollar, and is one of the main culprits in this problem we have in the mortgage mess.

Sorry, Dan, I know you think I am a broken record, but the truth is the Fed is one of those institutions that doesn't take blame for anything. Yet monetary policy drives so much of what the economy does these days.

HENNINGER: I am trying to guess what your big story of the year is.

O'GRADY: If you think about how the economy survived even through poor Fed management, I think it is a testament to tax cuts and the fact that we have a more open economy now. Free trade has helped the economy be more flexible in times whether it goes through difficult periods.

GIGOT: Easy to adopt. And we have labor markets that are flexible and people can lay off workers hire temporary workers. So we're much more adaptable, is that the point?

O'GRADY: Exactly. And you can't underestimate the value of how innovative the U.S. economy is. Everything from health, high-tech discoveries, medicine also, those things make the economy strong in bad periods.

STEPHENS: But we forgot what inflation looked like. I never knew what it looked like.

GIGOT: Too young.

STEPHENS: That's right. But look at energy prices and food prices in particular. And those are the staples. That's what people spend money on. And the Fed is discounting them as not belonging to core inflation. That's a real problem. If the economy tanks and we have inflation, we are back in 1976.

O'GRADY: You are not going to rain on my parade, Bret. This is a very strong economy.

GIGOT: All right, Dorothy, what's your big story?

DOROTHY RABINOWITZ, EDITORIAL BOARD MEMBER: My big story is the turn of our European allies, which they always were to the United States. I have to say one of the most successful pieces of propaganda ever put forth against the Bush administration and the war was the notion that we have caused -- lost the face all over the world. Every boor you meet at a bar- mitzvah or cocktail party will back you into a corner and say, but don't you think it is terrible how much we have lost face in the world? So this is a terrific antidote.

GIGOT: Which allies are talking about here?

RABINOWITZ: Well, of course, Sarkozy, in particular.

GIGOT: Of France.

RABINOWITZ: Of France, indeed. And Merkel in Germany and even Gordon Brown.

GIGOT: As I was saying, you are saying something nice about France. Is that what I am hearing?

RABINOWITZ: Yes. I think you have to Mark these moments carefully.

GIGOT: They come once a generation, I think.

RABINOWITZ: Well they have behaved. And yet when you bring this up to people, they are reluctant to give up. I mean this event is a turning point because it marks how deeply encrusted people have been invaded by this idea that has been perpetuated by editorial pages.

STEPHENS: Reality has foisted itself on Europeans in a big way. One was the idea they could escape terrorism by simply adopting an anti- American posture.

I think another powerful factor has been the rise of Vladimir Putin and resurgence of Russia as a belligerent nasty power, which reminded them they face a choice. It is America or the Russians. And I think they are taking a fresh look at the United States and rethinking their easy anti- Americanism.

GIGOT: All right, Bret.

We have to take a short break. When we come back, our look at the big stories of 2007.

(COMMERCIAL BREAK)

GIGOT: We are back with more of our look at the big stories of 2007.

Bret?

STEPHENS: Well, was there any policy for which failure was more widely predicted than Bush's decision to go for the surge when he announced it in January. Everyone from the realist on the right to liberals said this policy is doom to fail.

In June, before American troops had really come to full strength, Harry Reid was telling us this war as loss. Now you look at the statistics about what happened in Baghdad, not just the statistics, but the anecdotal evidence, and it is extraordinary. You are looking at IED explosions at their lowest level since 2004. The number of weapons caches the U.S. seized more than doubled. Civilian casualties down by 65 percent since June.

Then talk to reporters coming back they are saying cab drivers can now drive all over the city. Then in Baghdad, you will find sonnies and Shiite neighborhoods and Shiites in Sunni ones.

GIGOT: Who gets credit for this, Dan?

HENNINGER: Well, I would say two people get credit. First, obviously General Petraeus does. Probably should have been the Man of the Year.

GIGOT: He helped to develop the strategy he helped to develop.

HENNINGER: For the counterinsurgency strategy, yes. But General Petraeus did not get to Iraq on his own. George W. Bush put him there.

Keep in mind that -- you know people just go nuts at this comparison. The fact is Abraham Lincoln appointed U.S. Grant in 1864 after three terribly bloody years of war. Bush finally found his way to the right general. If this works out and Iraq succeeds, ten years from now, I think Bush's legacy will look better than it does now.

GIGOT: I give a couple others credit. J.D. Crouch, who is a deputy national security adviser in the Bush White House, who led the review internally, and also two outside analysts Fred Kagan, of the American Enterprise Institute and former Army General Jack Keane. They were the chief outside promoters of this and they made it -- they sold if to the administration and they helped to sell it to the American people and even to the Army.

STEPHENS: Sure. And victory has 1,000 fathers as they say but you are right. Bush took a lot of heat at the beginning of this year. This was a policy that was universally reviled. You can't sort of number the so-called experts who said it was going to be destined to fail. No one expected counterinsurgency could work in well this fast.

Finally, the other people who deserve credit and aren't getting it are the Iraqis themselves. People say there has been a failure of political leadership at reconciliation but reconciliation is happening on the ground all over Iraq.

GIGOT: My big story is the failure, the troubles of the Democratic Congress. Nancy Pelosi and Harry Reid came in with great expectations and left having lost all over the place, including on taxes and spending and so on. I think they overreached, over-interpreted their mandate and had a hard time governing.

O'GRADY: Paul, do you think it means trouble in November?

GIGOT: Of 2008? You know what I think they did? I think they put their moderates in a difficult circumstance. The 300 or so-called blue dogs, they have them on the record supporting tax increases. They have really made it very difficult for them. I think some of them may not be coming back.

But what you will see next year is you will see the Democrats, at the convention -- watch the political convention. Those people, Nancy Pelosi and Harry Reid might be on at 1:00 in the afternoon, 10:00 in the morning, but not in primetime.

HENNINGER: Wait a minute. I would like to make the condemnation bipartisan. I think we had two failed Congresses. The one before this was controlled by Republicans and they were kicked out of office because of their failures.

I think this will pitch into the election next year. There is a crisis of confidence building in government among the American people. They just whether the Republicans run Congress or Democrats run Congress, people are upset. And I think that's going to have an effect on the national election.

GIGOT: But I think it is right, but Republicans, no question. But their corruption is what the Democrats came in and gave them their opportunity. I think they have missed responding to that by, for example, not wiping out earmarks when they could have done that.

Ok, still ahead, will there be a latecomer to the presidential race? And will the international community be forced to face a nuclear Iran? A look at the stories you will be talking about next year when the "Journal Editorial Report" continues.

(COMMERCIAL BREAK)

GIGOT: Time for our panel predictions on stories in the year ahead.

HENNINGER: For the sheer fun of it, I would like to predict Mike Bloomberg will get into the race sometime next year.

GIGOT: The mayor of New York.

HENNINGER: The mayor of New York. For one thing, he feels he has to do it and now is the type. What I would find interesting is they are talking about spending upwards of spending $2 billion. An astonishing amount of money.

GIGOT: All candidates combined.

HENNINGER: Yes. Bloomberg will spend maybe a billion of his own money, or could. If he did that it would be fascinating because we would find out how powerful television is as a political medium. When Mike Bloomberg ran for mayor in New York he used a tremendous number of sophisticated television spots to push his opposition over the cliff. I think that's what he would do all over the country. We would see the effect it would have.

GIGOT: Mike Bloomberg is a serious guy. Doesn't he only want to spend the money if he can win?

HENNINGER: I think we'll get into a very interesting situation. They is a lot of discontent and disaffection in the country. I think we're in a context where it's right for a third party candidacy.

GIGOT: What state could he win? If you if want to be president you have to win states, electoral votes or win enough states so you throw it into the House of Representatives. What states could he win?

HENNINGER: Why not California? It is a state that's just tailor-made for Mike Bloomberg and what he stands for.

GIGOT: I see him as a spoiler, Dan. I think the Democrats are so eager to win, to take back power, while the Democratic candidate -- say it is Hillary Clinton -- may not be able to go over 50 percent, she would have a floor. I think he ends up electing a Democrat if he gets in.

HENNINGER: The FOX poll just said this week, or just last week I think it was, that Hillary favorables are now up to 49 percent. The highest they have been since 2001. I don't think we can really predict where any of these candidates will be say the middle of next year.

GIGOT: You heard it here from Dan.

RABINOWITZ: It's going to win the state of upper Manhattan.

GIGOT: Dorothy, your pick?

RABINOWITZ: My pick? Well, I think that in very short order Americans are going to be asking who is Barack Obama. This man has come forward like a Rorschach test for everyone to project this notion of what a Democrat candidate should be. He is the inkblot.

It is becoming clearer and clearer that this massive platitudinous, high minded expression pouring forth from Obama as -- it is beginning -- it is going to sit on people who are going to ask what is he saying? What does this mean?

This started at the convention speech where he gave this strange speech about no one is black, no one is white, no one is this.

GIGOT: People loved it, Dorothy.

RABINOWITZ: I know, exactly.

GIGOT: It propelled him to his current stature. The audacity of hope? Come on.

RABINOWITZ: That's right. I can tell you that this mass of non- meaning non-specific feelings, attitudes and programs is going to become unraveled soon when people look for programs.

O'GRADY: Isn't he just ABC, anybody but Clinton? Isn't that what the Democrats are saying?

RABINOWITZ: I think it's more than that. I think, together with Oprah, this is their time and people are much more hard minded than you give them credit for.

GIGOT: All right, Mary?

O'GRADY: My big story for 2008 is I think we will see change in Cuba. I am not going out on the limb and predicting Fidel Castro will ever die. That's too risky. But I do think he might be shuffled aside in 2008 and we could see a change in Cuba.

He temporarily gave power to his brother about 18 months ago and hasn't been seen in public since then. He has been videotaped now and then. He is apparently mentally frail.

I think that what we saw a couple weeks ago where he ruminated in a letter that maybe it is time to allow space for the younger generation is a suggestion that the regime is trying to give them the hook. And you know, the word around is that Raul Castro would like to develop something more like a China or Vietnam model for Cuba and we could see that in '08.

GIGOT: OK, let's hope that's true.

Bret?

STEPHENS: I think the big story is Iran will become a de facto nuclear power. I think something significant happened this month when the Russians decided to fuel the Bushehr reactor. Some say it is not a big deal. It is a civilian reactor. That reactor can be easily converted into a factory for weapons-grade plutonium.

Israelis talk about reaching points of no return in terms of a weapons program. That is a point of no return. With Iran becoming a nuclear state, you are going to see the de facto end of the Bush Doctrine.

GIGOT: Very briefly, you are saying there is no chance President Bush will use force against Iran between now and the end of his term?

STEPHENS: No, there is no chance that will happen. That has devastating consequences for the region.

GIGOT: Bret, thank you.

Thank you to you all.

We have to take one more break. When we come back, our "Hits and Misses" of the year.

(COMMERCIAL BREAK)

GIGOT: Winners and losers, picks and pans, "Hits and Misses," this week we call attention to the best and worst of the year.

Dan?

HENNINGER: Misses indeed. I will talk about the missed terrorist attacks of 2007. We all recall the Glasgow bombing in June. The day before, there were two undetonated car bombs in London. In September, the Germans arrested three Islamic terrorists attempting to bomb the Ramstein Air Force Base and Frankfurt Airport. And in February, there was an attempted assassination attempt on Dick Cheney in Afghanistan.

When these things succeed, we say they change everything. But when they miss, we all sort of relax. I think what we are going to see in the presidential race next year is just how relaxed we have become about a terrorist movement that truly is still trying to hit us hard.

GIGOT: Let's hope not too relaxed.

OK, Mary?

O'GRADY: My miss for 2007 is brought to us by our friend at the Federal Reserve. Headline inflation is now 4.3 percent. And we haven't seen the mullahs so feisty since the 1970's when inflation was also a problem in the United States. So I think that the Fed has missed the boat and will have to try to catch up in 2008.

GIGOT: We will live with the consequences for quite awhile.

Bret?

STEPHENS: I give a hit to Garry Kasparov. I know "Time" magazine thought better of the man who put the former chess champion, now political dissident, in jail by making Vladimir Putin Man of the Year, but I think that someone has to stand up and say here is a guy who had everything in the world. He was rich, world famous, could live where he wanted, instead he devoted himself to being a democracy activist in a country where that is hazardous to one's health.

A tremendous credit goes to Garry Kasparov for holding the banner of freedom and liberalism alive in a place where night is falling.

GIGOT: Do you think they would be daring enough or corrupt enough to try to harm him?

STEPHENS: I think they would be. In fact, the features of the Putin government is that it has gone after the most successful people in their field, Khodorkovsky as a CEO, Anna Politkovskaya as a journalist, why not Garry Kasparov? He has to be very careful.

GIGOT: All right, Bret.

Dorothy?

RABINOWITZ: This is a group miss redistributed at the media for largely helping to advance the insanity of the hate crime hysteria, which has grown more rampant this year as every swastika, every little scrawled sign against any minority appears on television is treated now as a major crime, which then leads to the most tremendous distortion of the meaning of what is a serious crime in the media. And so at Columbia you have nooses and swastikas. The media reports it, so there are more nooses and more swastikas that come out.

Finally, we is seen the logical extension of this madness where you have a student at Princeton who beat himself up very badly and then presented himself as victim of a hate crime, which should tell you exactly where victim status attraction has come nowadays. This feeding will never go away.

GIGOT: You want to bash the media. I want to praise the media or one person, Frederick Dicker, the Albany bureau chief of the "New York Post," the man who broke Eliot Spitzer. Old fashioned shoe-leather reporter broke the story Spitzer aides had tried to smear a leader of the Republican Senate. Everybody else praised Spitzer. This fellow has been around forever.

Albany is a nest of corruption as we know. He went out there, found this story, broke it despite the attempts to smear him in return and say he was not being fair. He did this great thing. And now we have Mr. Spitzer finally cut down to size by someone in the press corps.

Bret, you said something interesting, the Bush Doctrine now is dead. What do you mean by that?

STEPHENS: Look, the Bush Doctrine said a number of things. One is we won't let the Dangerous regimes get their hands on the dangerous weapons. We have North Korea as nuclear weapon state and Iran close to it. He said we weren't going to treat regimes that harbor terrorists like terrorist regimes and yet just last month, at the Annapolis peace conference, we had Syrians, one of the great sponsors of terrorism being treated as honored guests even as they are sponsoring Hamas and trashing freedom in Lebanon.

We have this revival of a peace process in Palestine, same tape that we watched in the 90's.

GIGOT: All right, we will watch that in the next year, Bret.

That's it for our year end edition of the "Journal Editorial Report."

Thanks to my panel and all of you for watching. We'll you here next week for complete analysis of the Iowa caucuses. I'm Paul Gigot. On behalf of everyone here, happy New Year.

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