Debacle in Subprime Loans Rocks World Markets

Overseas markets fear a wave of defaults in the turbulent U.S. subprime lending market. Defaults would crimp banks investing in those mortgages. It is not known how many banks overseas are invested in subprime mortgages, creating more panic.

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RENEE MONTAGNE, host:

The financial markets have been unpredictable for weeks now. And today, Asian stock markets ended their worst week in nearly a decade. Japan's Nikkei Average posted its biggest percentage drop since the September 11th attacks. And European shares have slipped back to negative territory in choppy trading today. Yesterday, Wall Street made a dramatic recovery from what was shaping up to be one of the worst days of a volatile summer of trading there. Much of this stems from continuing uncertainties about the mortgage industry.

And to find out what this all means, we turn to NPR's international business correspondent, Adam Davidson. Good morning.

ADAM DAVIDSON: Good morning.

MONTAGNE: Asian markets have been, as I've just said, badly hit today. All of the financial chaos seems to stem from fears that the turmoil in the U.S., the subprime lending market will hit banks and then snowball into serious economic problems. Why are overseas markets so vulnerable to the U.S. mortgage lending industry?

DAVIDSON: Well, there are two major ways. The primary way is that, you know, these subprime mortgages, these mortgages to people who probably can't afford to have a mortgage, poor people or people without credit, have been - they've used those to make investment products that people all over the world are invested in. So there are Asian banks, European banks, Latin American banks that are invested in these subprime mortgages, and as those go default, those banks are hurt.

But there's a huge secondary impact, which is more of a psychological, fearful, panicky impact, which is nobody now knows who's invested in those subprime mortgages. Nobody knows where they are. And it's creating this panicky feeling that you can't trust anything. I was thinking an analogy is, you know, you go to Las Vegas, you're playing blackjack or roulette or whatever, and you know that there are odds and you might lose money or you might win. But then you go to your ATM machine, you put your card in, you expect to get your hundred dollars. If the ATM machine start saying there's a 13 percent chance we'll give you your money, then you really start panicking because the whole world as you know it is kind of collapsing.

MONTAGNE: Right. Yeah, and - but traders on the floor of the New York Stock Exchange actually ended the day yesterday in cheers, started the day in losses. Why did it recover, and what does that tell us about what we might expect today on Wall Street?

DAVIDSON: There's a simple answer to why the stock market recovered yesterday and another simple answer to what it's going to do today - nobody knows. I certainly don't know. Nobody knows. This is a very volatile time. People don't know - people can't make calculated risk assessments because there is so much unknown rooted in this subprime mortgage lending that there's just a powerful feeling of panic. That is the word I heard over and over again talking to stock traders, talking to analysts yesterday. Panic. Panic. Panic. Which means irrational choices, almost random choices.

MONTAGNE: Now, the market volatility clearly matters to people heavily invested in the stock market. Of course a lot of people are. But what about those who are, you know, less dependent on it, and can we expect to see a largely impact on the economy?

DAVIDSON: I hate to use this phrase again, but we don't know. We just don't know. There is some scenarios that people play out that show how the subprime mortgage mess, the general uncertainty could really damage the overall economy, what economists call the real economy, could hit growth rates, could, you know, hit - make the entire U.S. and global economy slow down, even go into recession.

There are equally plausible scenarios in which it really just kind of blows over. It's going to take some time. And I think the best thing to do is, if you're not a day trader, if you're not really invested in the stock market, just kind of ignore this stuff. Don't go messing around with your 401(k). Just sort of ignore it. Don't worry, we'll let you know if it gets really serious for the overall economy.

MONTAGNE: Okay. We just have a couple of seconds, but we - you do have some investors screaming for a rate cut ahead of the Federal Reserve's next meeting in the middle of next month. Could the Fed alleviate the volatility by taking action?

DAVIDSON: Investors always want a rate cut. That is what they want. There's a fear that if the Fed does cut rates it will just reward people who took unhealthy risks. So the Fed is going to really fight against a rate cut before next meeting.

MONTAGNE: Adam, thank you. NPR's Adam Davidson.

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