Global stock markets suffered another day of steep falls on fears over the severity of the credit crisis – and the turbulence could be just the start of a much more protracted downturn, the Organisation for Economic Co-operation and Development warned.
With the price of oil flirting yesterday with the once-unimaginable level of $100 a barrel, investors fled equities for government bonds that might better weather any economic storm.
The FTSE 100 ended down 155.6 points – 2.5 per cent – at 6,070.9, after falls overnight on Asian stock markets. The Japanese market fell 2.5 per cent to its worst level since July 2006 and the selling continued through yesterday in the US, with the Dow Jones Industrial Average accelerating lower in the final hour of trading to close at 12,799.04, down 211.1.
Financial losses from the collapse of the US mortgage market could hit $300bn, the OECD said in its latest report, and it predicted that there could be additional negative consequences that will only come in waves. After years of free-and-easy lending, financial firms are making it harder and costlier to borrow money.
The organisation said: "As adjustments have often occurred in waves, and as higher funding costs take typically several months to have their full impact on companies or consumers, it may well be that the recent correction is only a precursor of a more protracted downturn."
Adding to the concerns of economists and investors yesterday was the high price of oil, which had set a new record of $99.29 per barrel of light sweet crude in early morning trading. It later slipped to $97.36, despite an unexpectedly sharp fall in US oil stockpiles, but investors continued to fear that persistently high petrol prices will eventually dampen consumer spending. The price of oil has risen by roughly a half since January and, adjusting for inflation, it matches the previous price peak during the Iranian hostage crisis of 1979-80. "The main reason behind the rise is the weak dollar against Asian currencies," said Rob Subbaraman, a strategist at Lehman Brothers. "We expect the weak dollar to continue for a fair bit, so this is not a short-term issue."
In both London and New York yesterday, financial stocks were the hardest hit, reflecting concerns about funding difficulties. Alliance & Leicester hit a seven-year low of 576p, while the buy-to-let lender Paragon plunged an additional 36 per cent as it began work on the emergency fundraising announced earlier in the week. Shares in Countrywide Financial, America's largest mortgage business, were down another 8 per cent.
And in a further sign of stress for the banking system, trading on the $2.8 trillion covered bond market was halted altogether until Monday after unusually high volatility led the European Covered Bond Council to fear for the financial security of market makers. The cost of insuring against defaults on European bank bonds rose to a record, notably for Barclays and UBS paper.
The ongoing turmoil in financial markets has its roots in profligate lending to low-income homebuyers, who have begun defaulting in record numbers. The US mortgage industry is now agreeing to offer special "pay-what-you-can" deals to struggling borrowers, to avoid triggering a wave of repossessions that could precipitate an even more serious housing market crisis.
Four major players, including Countrywide, signed up to a state-wide plan in California. All borrowers whose low introductory interest rates are set to expire will be kept on their existing monthly payments if a screen of their fin-ancial details suggests they would default on the higher, standard rate bills. About 500,000 Californians have taken out home loans that will rest higher over the next two years, governor Arnold Schwarzenegger said.