Why this is merely 'the end of the beginning'

Was that it? many investors may be wondering. Stock markets have rebounded whilst money markets have also calmed down. But the threat of further subprime contagion remains.

Was that it? many investors were wondering by early this week. Equity markets had rebounded, with the Dow Jones gaining 2.3% last week, while the FTSE 100 had posted six straight days of gains. Money markets had also calmed down, with the yield on three-month Treasury bills back to 4.5% as appetite for risk returned. And the US VIX volatility index, a gauge of fear in the markets, receded to 20, having hit 38 a level not seen since the invasion of Iraq in 2003.

But global jitters returned on Tuesday, with Wall Street suffering its worst day in three weeks. And volatility is set to continue. "We are a very long way from normality," as Charles Diebel of Nomura Securities says. The asset-backed commercial paper market, for instance, is still in trouble. According to Ambrose Evans-Pritchard on Telegraph.co.uk, the near-2% jump in the cost of borrowing for US and European firms and the $300bn of debt from leveraged buy-out deals stuck on banks' books are signs that the credit bubble underpinning the market rally of the past 18 months "has definitively burst the world has changed".

The main cause for concern is that "securitisation and other feats of financial alchemy have made it as clear as mud where credit exposures lie", says The Economist. With subprime derivatives dispersed around the world, problems have emerged in dribs and drabs; "this is not how markets like to receive their news".

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Throw in the problem that derivatives are thinly traded and hard to value, while banks do not have to report losses immediately, and uncertainty over the extent of subprime losses will linger. Markets won't stabilise until the "information crunch is eased", says Marco Annunziata of UniCredit. To make matters worse, mortgage-backed securities are set to be affected by delinquencies. Subprime defaults are climbing, as are those in the Alt-A market (a step up from subprime). Nationwide foreclosures have jumped by 93% in the past year. And the "mortgage pig is hardly through the python yet", says Garry Shilling of A. Gary Shilling & Co. Many subprime mortgages' adjustable rates are to rise, with most resets to occur late this year. All this raises the prospect of further contagion selling as institutions seek to make up losses on subprime exposure.

Another worry is that the worsening housing market bodes ill for US consumption, which has been underpinned by rising house values.

Over the past few days, markets have been pinning their hopes on interest-rate cuts by the Federal Reserve. But inflation is still above the Fed's target, while in the past, cutting rates to calm financial markets' nerves has encouraged the belief that the Fed will always come to the rescue if speculation goes wrong. It's "unseemly" watching "the avatars of free-market capitalism rely on the government to pay for their bad bets", as James Surowiecki says in The New Yorker. Cutting rates in the past has simply encouraged further speculation and stored up trouble; witness the tech bubble after the 1998 scare and the housing bubble post-2001. Cheaper money now will merely sow the seeds of the next financial crisis, says Liam Halligan in The Sunday Telegraph.

Given the scope for tighter credit and further subprime defaults to undermine US growth, the Fed may have to step in to shore up the economy rather than simply to prop up speculators. But would it help much? Bill Gross of Pimco notes that even cuts of 2%-3% wouldn't prevent adjustable-rate mortgages resetting. And would mortgage lenders "flush with fears about depreciating collateral" lower their tightening lending standards and mortgage-interest rates? Lower rates would also undermine the dollar, stoking inflation. With all these pitfalls ahead, the recent calm, as The Economist puts it, was "the end of the beginning".