Investors lose £56bn as markets plunge

By last night, central banks worldwide were calculated to have injected at least $326bn (£161bn) into the financial system in the space of 48 hours.

A major recovery on Wall Street later in the session in New York may offer investors some hope that fears of a greater meltdown are overdone, although even the more optimistic fund managers are cautious about ruling out further trouble in the short term.

Experts warned that current turmoil in global stock markets could have implications for UK consumers as lenders become more cautious.

Prime Minister Gordon Brown sought to calm the market, saying: "I think the important message to be sent is we have done everything in our power to maintain the stability of the British economy."

But, famously bearish Scottish fund manager Ian Rushbrook, who runs the £190m Personal Assets Trust from Edinburgh, warned of worse to come. He claims that the UK stock market is currently still overvalued by about 30%, although he has for a long time been among the most pessimistic on the outlook for equities and has 63% of his fund in cash.

Mr Rushbrook told The Herald last night: "It has taken an awful long time. It is certainly not over yet. It is just there has been no real appreciation of what the banking system is going through . . . It is a pretty startling day when the FTSE-100 loses 3.7%. This is just froth on the bubble."

He warned that banks globally might have to reduce their lending by up to $1200bn, if estimates that their capital would be eroded by $100bn because of the US sub-prime crisis were correct, given they are able to lend up to 12 times their capital.

Touching on the funding of massive deals done by venture capitalists, Mr Rushbrook said: "In terms of financing leveraged buy-outs, and they are stuck with those (loans), no-one is going to buy them off them, they are going to have to call in other loans. It is going to take at least three or four months for those to percolate through the system."

He believed that markets' hopes of being bailed out by a swift cut in US interest rates might be dashed by American inflation numbers next week.

Mr Rushbrook said: "We have a huge credit bubble. I think the situation is serious. The Fed is going to have to do something, but it may not be able to do something if the inflation figure is higher next week."

Julian Fosh, at Saracen Fund Managers in Glasgow, has been among the more optimistic on equity markets. He said: "It is very difficult to forecast in the short term what is going to happen."

However, citing the "disconnect" between the "pretty healthy" world economy and what was happening in stock markets, he added: "It is unlikely the credit thing is going to cause the world economy to collapse."

He saw investors shifting to larger companies, offering greater liquidity, and still saw value in FTSE-100 stocks such as BP, GlaxoSmithKline and the banks. New York's Dow Jones Industrial Average, which was showing losses of nearly 213 points at one stage during yesterday's session, finished down only 31.14 points at 13,239.54 last night.

The US Federal Reserve intervened for the second day running, as did the European Central Bank, as traders continued to take fright over the potential fall-out from massive loan default in the US sub-prime mortgage market, which serves people with poorer credit ratings.

French bank BNP Paribas on Thursday suspended trading in three funds, as the sub-prime shake-out reverberated through the international banking sector.

Fears of a credit crunch have been exacerbated by the raft of massive, debt-backed takeovers of blue-chip companies by venture capitalists.

The Bank of Japan had earlier yesterday attempted to arrest a slide in equities in Asian trading which was triggered by a sell-off on Wall Street on Thursday night. Central banks in Canada, Switzerland, and Australia joined in the concerted effort yesterday to ensure liquidity in financial markets and prevent the sell-off spiralling out of control.

The Dow finished Thursday's session showing a massive 387.18-point loss. This sent the FTSE-100, which had between Wednesday and Thursday lost more than 200 points, plummeting from the outset yesterday.

The FTSE-100 was last night down nearly 700 points on its close of 6732.4 points on June 15 this year - which had been its highest finish for nearly seven years. The index began a steep descent around the middle of last month.

In a statement issued before US stock markets reopened yesterday, the Federal Reserve pledged to pump money into the banking system as needed to keep financial markets running.

What has caused the crisis

What are sub-prime mortgages?
These are higher-risk mortgages lent to people with poor credit histories and low incomes, often at higher interest rates than the wider market. Banks and financial institutions were encouraged to lend to thousands of US homeowners by low interest rates but default levels have spiralled as borrowing costs in the US have leapt from just 1% to 5.25% in just two years, combined with a collapse in house prices.

Why are stock markets falling?
The trigger for the latest collapse in share prices came when French bank BNP Paribas suspended three of its funds with exposure to the US sub-prime mortgage market, because a "complete evaporation" of liquidity meant that it was unable to put a price on them.

The news from BNP caused other banks concerned by the possibility of more bad debts coming out of the woodwork to cut back on everyday lending to each other by raising the "inter-bank rate".

Is this a one-off?
No. There have been concerns over US sub-prime mortgages since HSBC warned in February over heavier-than-expected default rates from borrowers in the US struggling to keep up with mortgages. Since then, any further developments - such as last week's news that the US's 10th biggest mortgage lender, American Home Mortgage Investment, had filed for bankruptcy protection - have also given stock markets a jolt.

How have central banks reacted?
The European Central Bank injected 95 billion euros (£63bn) of emergency funding into European markets to try to improve liquidity and restore confidence.

How bad is it?
The FTSE 100 Index is trading below its opening mark for the year, of 6220.8, so all of the gains made so far in 2007 by London's leading companies have been wiped out by the turmoil. The losses come less than a month after the Footsie closed above the 6700 mark to reach a seven-year high.

What are the wider impacts?
The fears over US sub-prime mortgages have spread to the wider credit markets and made it more expensive for a host of private equity firms to raise the billions of pounds of debt they need to fund acquisitions, as institutional investors take a more cautious approach and demand higher returns.

How long will it last?
London's FTSE 100 Index had staged a brief recovery from the previous round of losses last week, until the announcement from BNP Paribas shook the markets.

Confidence is fragile because investors are unable to guess the extent of the damage and some analysts say logic is going out the window.