Markets Gird for Fallout from Subprime Loans The world's financial markets are bracing for another volatile week as investors worry about the effects of widening losses tied to subprime mortgages. On Friday, the U.S. Federal Reserve pumped more liquidity into the banking system to reassure the financial markets.
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Markets Gird for Fallout from Subprime Loans

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Markets Gird for Fallout from Subprime Loans

Markets Gird for Fallout from Subprime Loans

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This is WEEKEND EDITION from NPR News. I'm Rebecca Roberts.

Last week on Wall Street was something of a rollercoaster ride. Thursday's news was bleak.

UNIDENTIFIED WOMAN #1: When the dust settled, the Dow tanked 387 points, its second worse day of the year. And NASDAQ Composite plunged 56.

ROBERTS: Friday's market threatened another slide until the Federal Reserves stepped in.

UNIDENTIFIED WOMAN #2: The Federal Reserve injected billions of dollars into the nation's banking system four times between yesterday and today.

ROBERTS: By the end of Friday, the Dow was only down 31 points. Investors could be forgiven for feeling jittery.

UNIDENTIFIED WOMAN #3: I think probably it's going to be hard to get a good rate even though we have very, very good credit. So I'm a little - really nervous about that.

ROBERTS: She's not alone. After a week like that, what will next week bring and how will the repercussions be felt outside U.S. borders?

NPR's Adam Davidson has been following these issues. Adam, can you just give us a quick summary of what happened last week?

ADAM DAVIDSON: Well, what happened last week is something called a global liquidity crisis. Now…

ROBERTS: Easy for you to say.

DAVIDSON: Yeah, I know. What does that mean? It means there was just not enough ready cash available for banks to conduct their day-to-day business. Every day, every bank in the world checks to see how much cash they have. The banks that have extra cash lend it to the banks that need cash just for that day's business. These are very short-term overnight loans.

But what happened last week is banks started worrying that they shouldn't lend money to other banks because a surprising number of banks have assets that are backed by the subprime mortgages in the U.S. These are these mortgages that went to people who normally couldn't get a mortgage because they're too risky. They don't have a good credit history. And people are defaulting on those mortgages more and more, which means the very assets that underlie these banks' ability to borrow money from each other is disappearing, and if they don't have ready cash, that means lots of other people in the economy don't have that day-to-day ready cash. And without that, the economy really grinds to a halt.

ROBERTS: So when they stop being nervous, and when they get this added liquidity from Central Banks and Federal Reserve here in the U.S. and Central Banks around in other countries, will they get over the crisis? Is this something we're going to continue seeing next week?

DAVIDSON: If this crisis continues and banks continue to be really nervous about lending money, a company can't get the money it needs to pay its payroll and then the workers don't have the money they need to pay their rent or to buy a new car or washing machine. And then the car company doesn't have the ready cash it needs to pay its suppliers and on and on.

And there's a real fear that this liquidity crisis will mean just a lack of cash out there and as economists say it will leave just the financial world into what economists call the real economy, into companies that actually make things and people that need to pay mortgages, that need to pay their rent. And if that happens, you have a real risk of a slowdown of the economy and an actual recession.

But we really don't know. There's a very good chance this will all kind of blow over in the next couple of days and people will calm down. The financial markets will go back to normal.

ROBERTS: And what tea leaves should we be reading if we're trying to figure out whether this is a couple of days and it will blow over or whether this is a long-term-headed-towards-recession problem?

DAVIDSON: Well, I think, don't look at the stock market. The stock market is always very volatile. Look for more and more banks freezing their funds. More and more banks saying they don't have enough money to operate on a daily basis. If we see that happen, if we see this subprime mortgage worries spread to more and more financial institutions, those are the things that show it's spreading and it's scary.

ROBERTS: The subprime mortgage market has been blamed for a lot of the problems with U.S. banks. But one thing that's been odd to watch is how that's trickling out across our borders causing problems in France and Germany. How did this become a global issue?

DAVIDSON: Well, it happened two ways. First, there's a surprising number of banks invested in subprime mortgage fund. But there's a secondary effect. Financial institutions, they see the subprime mortgage thing blowing up and it creates this concern throughout the financial markets where banks and others start saying, I don't want to give money to anything that isn't optimal. So I don't want to give money to companies that aren't the best companies. I don't want to give money to countries that aren't the best countries. And that seems to be happening where the amount of credit out there is shrinking.

So countries that are very risky: South Africa, Iceland, Latvia. These are countries that have a lot of debt, that are really risky bets. They've been able to get money until now, but there's a fear that money will be sucked away from them and they're going to face really severe economic crises.

Again, not guaranteed, maybe not even likely, but certainly possible.

ROBERTS: NPR's international business correspondent Adam Davidson. Thanks, Adam.

DAVIDSON: Thank you.

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