Two weeks ago a 9% slide in the Shanghai Composite index and comments from former Federal Reserve chairman Alan Greenspan implying the US economy might slip into recession by the end of this year played havoc with global stock markets.

The New York Times columnist Paul Krugman immediately penned a column, supposedly written a year hence in February 2008, looking back on the seeds of "the great market meltdown of 2007".

"What made the market so vulnerable to panic?" he wondered, arguing it wasn't another burst of what Greenspan had, in 1997, memorably called irrational exuberance - rather a matter of "irrational complacency".

Then reality began to intrude. "By early 2007," Krugman went on, "the collapse of the US housing boom had brought with it widespread defaults on sub-prime mortgages - loans to home buyers who fail to meet the strictest lending standards. Lenders insisted this was an isolated problem which wouldn't spread to the rest of the market or the real economy. But it did."

This aspect of Krugman's crystal ball gazing produced almost instant results. On March 5, Europe's biggest bank, HSBC, announced a $10.6bn (£5.5bn) surge in its bad-debt provisions, largely to cover rising defaults on lending by its American consumer credit subsidiary, Household International, acquired in 2003.

Other big sub-prime lenders across the Atlantic, like New Century and Accredited Home Lenders, were either fighting off bankruptcy or desperately seeking fresh injections of capital. This Tuesday the Dow recorded its second largest fall in four years, spooked by fears that the US housing boom might indeed collapse.

Then yesterday the Footsie plunged another 2.6% to within a whisker of its 6000 floor, its lowest close since October. Banks took a particular hammering, signalling further fears that the HSBC effect might not be the end of this particular story.

A disorderly unwinding of that American housing boom - shots of proliferating For Sale signs on US lawns are already peppering television news screens here - might not stop there. Panicking home owners could then tighten their grip on their pocket books and trigger a severe downturn in demand in shopping malls too.

Worse, hedge funds and other investors in bundled sub-prime mortgage securities might begin to feel the heat. A chain reaction of messy insolvencies and further stock market mayhem could follow. Greenspan's hint of imminent recession over there seems to be gathering some disturbing substance. Or is it?

Sub-prime lending has been a growth industry in the United States for the past decade. From the Clinton presidency onwards, Congress pushed policies aimed at wider home ownership, even among the poor and minorities. As a result, nearly 69% of all American households now own their own home, the highest level in history.

But the sub-prime lending that has made that possible comes with many strings attached. While mainstream mortgage lending in the US tends to be at a fixed interest rate for the whole life of the loan, most sub-prime lending is made at variable rates. And the changes, when they come, can be punitive.

Four out of five sub-prime loans come with floating rates which, after the first year or two, are varied annually in line with prevailing short-term interest rates. For those who took out such loans in 2004 or 2005, aggressively marketed when US interest rates were at a rock bottom 1%, it must at first have looked like a great deal. While millions of households with poor credit ratings expected to pay higher rates for their money - up to twice the rate of prime mortgage borrowers - that wasn't so bad when the Federal Reserve, under Greenspan, brought its main rate down to 1%. However, from the summer of 2005 onwards, the Fed implemented 17 successive rate hikes, taking them to 5.25%.

Thanks to that relentless monetary tightening, more and more holders of sub-prime mortgages are now facing increases in their monthly repayments of between 30% and 50%. More and more of them can't pay. And so defaults and repossessions are spiralling.

The non-profit Centre for Responsible Lending (CRL) believes 2.2 million households in this market have either lost their homes or face that prospect over the next few years. The cost to those home owners could be as much as $164bn. The default rate on sub-prime mortgages reached 14.4% in the final quarter of 2006. According to CRL, it could reach 19%, nearly double the expected rate back in 2002.

There are some $650bn worth of sub-prime loans out there. But only around 6% of all home owners have sub-prime loans with adjustable rates. So it is by no means a foregone conclusion that the pain being felt by this new generation of American home owners and the risk of bankruptcy stalking the likes of New Century will pull the whole American housing market down with it.

The stock market scares of recent weeks tell us more about the changing attitude to risk among global investors than about the impact of this specific cause or that one. As Krugman puts it, investors rush for the exits, not because of external events, but because they see others doing the same.