PARIS : The turmoil on global stock markets stemming from bad investments in high-risk US property loans has sparked fears of broad repercussions for the global economy.
Only three weeks ago the main US stock index, the Dow Jones Industrial Average, broke through 14,000 points for the first time in its history and other markets worldwide have been at record highs in 2007. A sharp reversal in sentiment and steep losses in the last few weeks, most markedly in the last two days, has led analysts to speculate about whether falls in stock prices mark the start of a downturn or a simple, overdue correction.
The turning point came last month when a US bank, Bear Stearns, spooked the markets with news of major losses and accounting difficulties with its investments linked to risky US housing loans.
Losses by other banks and investment funds have led to what has been termed the "US sub-prime housing crisis."
Sub-prime loans are housing loans made by lenders to individuals with poor credit histories and are therefore extremely risky.
Following years of booming house prices and cheap credit -- interest rates have been low by historical standards -- the US housing market is now in reverse with loans becoming more expensive and prices falling.
This has caused high numbers of defaults and repossessions as borrowers, particularly high-risk sub-prime borrowers, struggle to keep up with their mortgage payments.
The human face of the current financial crisis is likely to be a low-earning American, possibly someone who took on a mortgage they could ill-afford and whose mortgage broker did inadequate checks on their ability to repay.
The link between these people and turmoil in financial markets involves a piece of financial trickery that has enabled banks and funds all over the world to make investments that are essentially bets on borrowers repaying their mortgages.
Funds looking for a high-risk, high-return investments have bought unknown numbers of innovative securities called mortgage-based securities (MBS) or asset-based securities (ABS), and their variants such as collateralized debt obligations (CDOs).
Questions about the scale and scope of these investments -- i.e. who has bought them and how much are they exposed -- is behind the volatility on world stock markets with investors waiting to see who has been caught short.
So far, banks in Germany, Australia and Britain have revealed losses and several hedge funds have closed funds because of severe losses.
The sharp falls on Thursday and Friday were sparked by an announcement by French bank BNP Paribas that three of its investment funds had been suspended because of their exposure to sub-prime loans.
"The big question is what is the overall amount (of sub-prime-linked investments) and this is bad for the markets because if there is one thing that the markets hate, it is uncertainty," Gilles Moec, senior economist with Bank of America in London, told AFP.
So far, so bad -- but losses by a few risk-loving investors is only half the story with the real danger to the global economy the consequences that might trickle down to consumers or companies.
Banks are now setting aside cash as a precaution against further losses from their bad investments and have become far more cautious about lending.
This is known as a "credit squeeze," but the fear is that this could become a veritable "credit crunch" in which companies and consumers have inadequate access to loans.
"As private sector banks, in a time of uncertainty, set aside more funds for their own funding needs, we are seeing a shortage of liquidity in the money markets," explained Societe Generale's chief Asia economist, Glenn Maguire.
A shortage of liquidity would restrict the ability of companies, and eventually consumers, to borrow, potentially slowing economic growth worldwide.
As a result, central banks across the world have been pumping money into the banking system by offering loans at attractive interest rates to commercial banks in the hope of forestalling a damaging crunch.
The European Central Bank put a record 94.8 billion euros in on Thursday and followed up with another 61.05 billion euros on Friday.
For some, the tightening of borrowing conditions is well-overdue and the sub-prime crisis is a sting in the tail after years of easy money and lax lending by banks and mortgage brokers.
The consequences for the stock market could be serious, however, particularly given that much of the rise in stock prices in recent years has been caused by aggressive takeover activity by private equity companies.
Private equity groups, investors that specialise in increasing profits at underperforming groups, rely on large amounts of debt to finance their acquisitions and they might now have difficulty finding financial backing.
"There are two things I am more or less sure about," said Philippe Waechter, senior analyst at French group Natexis Asset Management.
"One is that the financing problem in the housing market is going to continue. The other is that on the markets there is going to be a lot of volatility and for the moment one can't say if the low point has been reached." - AFP /ls
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