The subprime crisis hits the mainstream

The latest market slump has come about because one of the big US lenders finally confirmed we’re no longer looking at just a subprime crisis. We‘re looking at a crisis, full-stop…

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We werent planning to return to the credit crunch so soon.

But when the Dow Jones falls 226 points in a single session, and the FTSE 100 sheds 125 points on the same day, you cant let it pass without comment.

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We've been talking about the subprime crisis, and how the ill effects wouldn't be confined to the poor and desperate (as many had hoped), for a while now.

And the latest slump in the markets has come about because one of the big US lenders has finally confirmed we're no longer looking at just a subprime crisis.

Were looking at a crisis, full-stop

The top mortgage lender in the US, Countrywide Financial, dropped a bombshell on the markets yesterday. It warned on profits, as it reported that its subprime problems had spread to its prime mortgage book. Its second quarter net income fell by 33% to £235m, as it wrote down "the value of home loan assets related to borrowers with strong credit ratings by $388m," reports The Times.

Countrywide has slashed its subprime lending in half - they now account for just 4% of new loans. And yet, this "decline in high-risk lending failed to outweigh a surge in late payments on its prime loans." Things aren't going to get any better. Chief executive Angelo Mozilo warned that in the second half, "we expect difficult housing and mortgage markets conditions to persist."

It cannot be exaggerated how much of a nightmare this is for credit markets. The fact that even prime customers are now having problems repaying their mortgages has to suggest that anyone holding any type of subprime-backed mortgage bond is basically holding worthless paper.

Bill Gross of bond fund Pimco warned of a "sudden liquidity crisis" in the junk bond market, and it's no surprise. Companies are finding it almost impossible to raise money, and the fear in the credit markets is threatening a number of takeovers that have hit the headlines in recent months.

The latest potential casualty is the £2.4bn private equity buy-out of music publisher EMI, by Guy Hands's Terra Firma group. Mr Hands needs the backing of 90% of the group's shareholders to go ahead with the takeover. So far, he's got 26%, and has until Sunday at 1pm to get the rest.

Now, in more forgiving circumstances, he'd simply extend the deadline. But he needs the backing of Citigroup, the deal's financiers. And according to The Times, Citigroup hasn't yet agreed. "They were quite happy to lend it a couple of months ago," said the newspaper's source. "But now the market conditions have changed. If we don't get it, there is a good chance the deal will collapse."

It's small wonder. Bank have committed to around £121bn worth of deals that they have yet to offload onto the debt markets. As The Times says, this has "prompted several banks, including Citigroup, JP Morgan and Deutsche Bank, to refuse to lend any more money until they have cleared their books of previous financing commitments."

With the money drying up, it's only a matter of time before one of these deals actually collapses. And then the panic will really start.

You can find out more about the credit crunch, and what it means for your investments, in this week's issue of MoneyWeek, out on Friday.

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Turning to the wider markets

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The FTSE 100 fell 125 points to 6,498. BP fell 11.5p to 590p as chief executive Tony Hayward warned of further pressure on earnings due to cost inflation. For a full market report, see: London market close

On the Continent, stocks also fell sharply. The Paris CAC-40 shed 101 points to close at 5,907, and the Frankfurt DAX-30 dropped 137 points to 7,806.

Across the Atlantic, the Dow Jones fell 226 points to close at 13,716. The tech-laden Nasdaq was 50 points lower, at 2,639, and the S&P 500 fell 30 points, to 1,511.

In Asia, this morning, the Nikkei 225 fell 143 points to 17,858.

Crude oil was trading at around $73.36 this morning in New York, while Brent Spot was at $75.60 in London.

Spot gold was trading at around $678 this morning. (For in-depth daily gold reports, see: investing in gold. Silver, meanwhile, was trading at $13.10.

In the currency markets, the pound was at 2.0575 against the dollar and 1.4921 against the euro this morning. And the dollar was at 0.7256 against the euro and 120.08 against the Japanese yen.

And in London this morning, mortgage bank Northern Rock reported that first-half profit had risen by 0.2%, below analysts' estimates, as demand for mortgages slowed and borrowing costs rose.

And our two recommended articles for today...

Gold: Insurance or risk asset?

- Gold up, everything else down? Stranger things have been known...such as the four years of strong correlation between gold and the stock market starting in 2003: Gold: Insurance or risk asset?

Brazil's consumers reach for their wallets

- Most of the action in emerging markets in 2007 has been in Latin America, with the most buoyant major market being Brazil: Brazil's consumers reach for their wallets

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.