World stock markets continue to take a turn for the worse. The latest concern of speculators is not just a possible slowdown in the US economy hitting economic growth in the rest of the world. It is also the collateral damage from the falling US real estate market.
In the great bubble that was US housing in the five years up to summer 2005, many Americans started to speculate in house purchases, while others were desperate to get on the housing ladder. So they looked for mortgage loans that they could ill afford. The banks and finance houses of Wall Street were happy to lend these dubious borrowers the money, given the boom on the homes market.
These 'sub-prime' loans, as they were called, were hugely risky for the borrowers and would be a disaster for the banks if the housing market collapsed. And it did. House prices have dropped from rising 15% a year in 2005 to an absolute fall now.
As a result, many sub-prime borrowers have gone bust and cannot pay their mortgage payments. The latest figures showing nearly 14% of such borrowers in default sparked off the fall in stock markets yesterday.
Of course, most mortgage borrowers and homeowners are not sub-prime. These high interest-rate loans are just 10% of the total mortgage market. But the worry is that many banks have packaged up their loans in the sub-prime market and 'sold' them on to other banks. This diversification of risk means that sizeable sections of the mortgage industry are 'exposed' to the sub-prime market.
Now the second-largest sub-prime lender, New Century, has said that it cannot pay back its creditors and lots of small sub-prime lenders have gone to the wall. The risk of a general financial sector default has risen.
Some bourgeois investors are worried that a further collapse will weaken the US economy further and cause a 'domino' effect across the world.
Stock markets are now down by about 6% since the latest scares began, still less than the sell-off in May 2005. But even if markets should eventually recover again as they did last year, this ripple is yet another confirmation that it is only a matter of a relatively short time (six months to three years) before a major downturn in the financial sector (and with it, the rest of economy) takes place.