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Last Updated: Tuesday, 22 January 2008, 14:39 GMT
Q&A: Stock market falls
Hong Kong trader

Global stock markets are into their second day of hefty falls.

On Monday, European markets suffered their most severe falls since the attacks of 11 September 2001.

Why have they suddenly been falling so sharply and can anything stop them?


What has kicked off these falls?

Stock market investors around the world are very worried about the state of the US economy.

Some US banks have decided that their economy is already in recession or are predicting that it will be soon.

There were high hopes that a stimulus package announced by President George W Bush would give everyone a lift last Friday, but in the event, it was disappointing.

Why does everyone care about the US economy so much?

US consumers and businesses are big customers for almost every country.

So far, some stock markets such as the Shanghai Stock Exchange had appeared immune to the US economy, but its main index has now lost 17% in six trading days.

Even if the US is not your biggest customer, a recession there would be bad news for your other trading partners and the knock-on effects would hit almost everybody.

What has gone wrong in the US?

All of the problems were kicked off by record levels of defaults on sub-prime mortgages in the US.

Sub-prime mortgages are offered to people with inferior credit records or unpredictable incomes.

President George W Bush and Treasury Secretary Henry Paulson
President Bush's stimulus package was not enough to stop the slide

It turned out that US lenders had been repackaging the debt and selling it to banks worldwide.

The default levels meant that the repackaged debt was of questionable value.

Suddenly, banks worldwide were reluctant to lend money to each other, because they did not know which banks were creditworthy any more and they were not sure how much of their own money they could afford to lend.

This became known as the credit crunch and it has made it harder for banks, companies and consumers to borrow money.

But we have known this for ages, haven't we?

We have, but nobody knows how severe the slowdown will be or whether there will be a recession in the US.

After President Bush's stimulus package turned out to be a disappointment, there were also signs that the US downturn was having an even greater effect worldwide than had been thought.

It was reported on Monday that Bank of China was about to announce huge write-downs, or losses, from investments linked to US sub-prime mortgages. On Tuesday, the bank's shares were suspended ahead of an announcement.

Write-downs happen when a company says that something it owns is worth less than it had previously thought.

Also on Monday, Germany's WestLB said it expected a net loss of one billion euros ($1.4bn; 740m) because of its sub-prime exposure.

What can stop the falls?

That's a tricky one.

The US central bank has been cutting interest rates and on Tuesday slashed its main borrowing cost to 3.5% from 4.25% in a shock move aimed at shoring up investor sentiment.

At the same time, President Bush has proposed big tax relief plans.

None of that seems to have convinced investors that a US recession can be avoided, with huge consequences for the global economy.

The big question is whether we are just seeing a bad month for shares - or whether this is the start of a bear market that could see share prices sliding for years.

Officially, a bear market is one in which shares are trading 20% below their highs.

Some major stock markets are already bear markets and many others are close to that stage.

Why should I care?

If there is a US recession and it triggers a global slowdown, then everybody will feel its effects.

Jobs will be less secure and many people will have more difficulty borrowing money for things such as house purchases.

As for the stock market falls, Monday's declines brought about the biggest widening of the deficits of UK pension schemes since they introduced the current way of calculating them in 2001.

So if you are saving for a pension, these falls could eventually leave you with less to retire on.

Also, you can look at share prices as a prediction that companies are going to make smaller profits this year.

If companies make less money, they pay less tax to the government, which must then either cut its spending or look for other sources of funding.

And that could hit you in the pocket.



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