Credit crunch: markets in decline

Last Modified: 10 Aug 2007
By: Andy Davies

Financial markets around the world have fallen sharply for a second day wiping billions of pounds off share values.

The Dow Jones index in New York is also in decline. That's in addition to yesterday's losses which saw the market lose almost 3% of its value. Shares in London, Tokyo and Paris also fell amid fears of a global credit crunch, affecting both businesses and individual investors.

The markets have been shaken by fears about the exposure of financial institutions to bad debt in the United States, where lenders have been offering loans to consumers with a poor credit history.

Worldwide markets fall

What happened? Stock markets around the world have dropped: New York's Dow Jones share index was down 0.9 per cent; London's FTSE 100 share index fell 3.1 per cent; the Paris Cac index was down three per cent; and Germany's main Dax dropped by 1.6 per cent.

Why? The crisis of the US sub-prime mortgage market (lending to people with poor credit histories) has exposed financial institutions to bad credit. Banks are now trying to protect themselves by charging more for the money they lend. Concerned traders have, as a result, become more cautious on the market floor.

Which means? It'll be harder for banks, companies and consumers to access loans and cash which could, in turn, lead to a global recession.

What is being done? At the moment central banks around the world are injecting cash into financially troubled banks to "assure orderly conditions" in money markets".

The first signs of trouble appeared in February when lenders reported record defaults in so-called "sub-prime mortgages".

The banks couldn't recoup their money because house prices in America have been falling. The recent collapse of American Home Mortgage, the 10th largest lender in the US, has intensified those concerns.

France's biggest bank, BNP Paribas announced yesterday that it was freezing three investment funds that had invested in the troubled US mortgage market.

The announcement triggered what in old-fashioned language is a run on the banks. In response, central banks around the world have moved to prop up markets by lending money to banks who might be in trouble

The European Central Bank, paid a record 65 billion pounds into money markets. That's the largest amount ever provided in a single operation and more than it paid out to stabilise credit markets after the terror attacks on September 11th.

The US Federal Reserve followed by adding $24 billion to the U.S. banking system. In Japan the central bank added $8.4 billion to money markets.

The worry is that should banks make losses, it would hurt their earnings and their profitability, making them less willing to fund the takeovers and buyouts that have underpinned much of the stock markets' recent gains.

If this happens, analysts say the crisis could make it harder for banks, firms and consumers to get access to loans and cash. This would be a drag on the economy and could cause a recession.