The dangers to us all from the 'spread of financial risk'

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It's really starting to look nasty out there.

The Dow Jones dived more than 150 points yesterday, and this morning the FTSE 100 has plunged below 6,000.

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US retailers are warning on sales left, right and centre. First Wal-Mart and Home Depot on Tuesday, then yesterday department store group Macy's reported a 77% fall in second quarter profits, and warned that third quarter sales would be flat.

The main problem for the iconic chain seems to be a slump in home furnishing sales, caused by the havoc in the housing market.

And the latest data shows that things are only getting worse

US home sales continued to fall in most states during the second quarter, according to the National Association of Realtors. Sales in Florida were down 41%. The median house price - at $223,800 - is now "down roughly 10% on the peak 16 months ago", says Ambrose Evans-Pritchard in The Telegraph.

Meanwhile, investment bank Merrill Lynch has warned that Countrywide, America's biggest home lender, is in danger of bankruptcy. "We fear the acceleration of margin calls and forced asset sales in the capital markets could lead to more problems for it to finance its mortgage operations."

Even though Countrywide isn't heavily exposed to the sub-prime sector, frightened investors are now steering clear of all mortgage-backed securities. They just don't know what's in them. So you can't offload even prime' mortgage debt anymore. Bruce Whitehurst of the Virginia Bankers Association said: "The investors we sell to, their credit has diminished. They get most of the money from Wall Street, and if they don't have the money to fund the loans we want to sell to them, we don't have as many outlets to sell to."

Another prime lender, Thornburg, had to put off paying its dividend as creditors issue margin calls (in other words, ask it for more money) to cover the falling value of the mortgages used as collateral for its loans.

"There is no question that problems in the sub-prime market are spreading to other areas of mortgage finance," said David Seiders of the National Association of House Builders.

It's spreading everywhere else too. Mitsubishi UFJ and Sumitomo Mitsui, two of Japan's biggest banks, saw their stocks hammered after reporting losses on US subprime. Everywhere, from Australian hedge funds to German and French banks, subprime is rearing its ugly head.

Some people - some of them merely weeks ago - said this was the great thing about credit derivatives. They spread the risk through the financial system, so that it doesn't land on one person's balance sheet, meaning theres less risk of a devastating collapse.

But hold on a minute. What actually happened here? One group of greedy feckless speculators (US mortgage lenders and those who backed them) dished out free money to another group of feckless speculators and some downright crooks (US subprime mortgage borrowers).

In the old days, the feckless lenders would have paid the consequences of their reckless lending in full. They'd have gone to the wall, the US economy would have taken some pain, and lessons would have been learned (well, until the next time, anyway).

But in our brave new, derivative-scattered world, everyone is suffering. How is this a good thing? Why should your UK-invested pension fund be taking a hammering because a bunch of lemmings on Wall Street think it was a good idea to lend limitless sums to people with no jobs?

Share financial risks with these fools? No thanks. I've got enough risk of my own to manage without having to worry about the stupid decisions that other people make as well. I imagine you feel the same way too.

But we're all stuck with it now, thanks to the derivatives bubble. And the fall-out is going to get worse - much worse. Merryn Somerset Webb explains why in the latest issue of MoneyWeek, out tomorrow. If you want to find out what the City isn't telling you, you really dont want to miss this one. If you're not already a subscriber, you can sign up for a three-week free trial by clicking here: Sign up for a three-week free trial of MoneyWeek.

Turning to the wider markets

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In London, the FTSE 100 ended the day in the red, falling 43 points to 6,109. The blue-chip index fell as low as 6,041 earlier in the session, but shares clawed back some of their losses on signs of a Wall Street rally. Housebuilders including Persimmon and Barratt Developments made the biggest gains of the day on expectations that interest rates will stay on hold for now. And financial stocks dominated the fallers once again, with Northern Rock falling over 5% to a three-year low on fears that the mortgage bank is to issue another profits warning. For a full market report, see: London market close.

On the Continent, the Paris CAC-40 was 35 points lower, at 5,442. However, the Frankfurt DAX-30 added 20 points to end the day at 7,445 as strength on Wall Street boosted sentiment and offset earlier losses.

Across the Atlantic, early signs of a rally petered out amid ongoing credit concerns. The Dow Jones fell 167 points to close below the 13,000 mark - at 12,861 - for the first time since April. A 13% share price tumble for mortgage lender Countrywide Financial helped to push the S&P 500 down 19 points to 1,406 and into negative territory for the year. And the tech-heavy Nasdaq ended the day 40 points lower, at 2,458.

There were also sharp falls in Asian markets today, with financials once again weighing heavily. The Japanese Nikkei was down 327 points to 16,148 and the Hang Seng was down by as much as 709 points, at 20,666.

Having rallied yesterday on reports of a drop in weekly supplies, crude oil had fallen over 1% this morning and was last trading at $72.43. In London, Brent spot was over 2% lower, at $69.47.

Spot gold was down to $665.30 from $668.80 in New York late last night. And silver had fallen to $12.49.

In the foreign exchange markets, the pound was trading near its lowest level in two months against the dollar - at 1.9823 - and was at 1.4774 against the euro. And the dollar was 0.7452 against the euro and 115.87 against the Japanese yen.

And in London this morning, stocks took their lead from the US and Asia to begin the day with sharp falls. The FTSE 100 had tumbled 120 points to as low as 5,989 as of 9.30 this morning. Elsewhere in Europe, the Paris CAC-40 had fallen by as much as 113 to 5,329 and the Frankfurt DAX-30 was as low as 7,298, having slid 147 points in early trade. And Northern Rock had slumped a further 5% after Merill Lynch and JP Morgan Chase both significantly trimmed their share price estimates.

And our two recommended articles for today...

What the market turmoil means for the oil price

- Credit concerns have caused stockmarket corrections around the world, prompting talk of an economic slowdown. Oil has already retreated from recent highs - but is it set to plunge much further? For more on the future direction of the oil price - and how Garry White has found an unlikely ally in Hugo Chavez - read: What the market turmoil means for the oil price

Four ways to dodge the credit crisis

- Marc Lichtenfield of the Smart Profits report examines what credit contagion means for your portfolio - and suggests four ways to keep your investments safe - here: Four ways to dodge the credit crisis