What exactly are the "credit worries" associated with the current downturn in the US stock market?

The US stock market is experiencing a mild sell-off in the the recent weeks (August 2007). People keep talking abotu credit worries that lending companies and maybe even banks may be facing. What exactly is this worry/problem in the credit market, and how serious is it? What is the worst that can happen in the credit market fails? Where is this lack of liquidity (cash) coming from? Thanks. William is correct, except that the most recent worries include the fact that the credit problems are not restricted to the subprime market, but borrowers with better credit and income are also defaulting on mortgages.

The result is that credit is being tightened for virtually all borrowers, not just the subprime ones. I'd agree that liquidity is low, which is why central banks around the world are pumping money in to the market.

The issue is why. Although subprime is a mess, there isn't actually a huge loss going on. All mortgages are secured on real property, which means that while the mortgage company is not short of assets (they take the house if you default on the mortgage) they are short of cash (because the mortgagees have stopped paying).

Mortgage companies can (and probably are) coming to an understanding with a lot of the mortgagees to reduce payments but to keep on paying something - that's the cash the companies need to stay in business. However, they also have to stop lending as much money, making mortgages more difficult to get, and they also will put rates up, because their own borrowing from banks has increased.

All of this means that the mortgage situation is self-correcting over time; the real property hasn't gone away, the mortgage companies will be able to offload the foreclosed properties for cash, and the market will calm down. It just takes time.

I'll make this simple

You put your money in the bank and buy stocks
Then other people borrow that money to buy stuff and do business

Right now people are not putting enough money in for companies to borrow and to continue doing business

This causes a credit crunch preventing people from doing business and making profits

That is why the feds (in many countries)are making more money available to banks to loan

The main worries that have caused a lot of problems are the sub-prime lenders. With the housing market being so hot the last 5 years, many of these sub-prime lenders were willing to take a risk on people whose credit wasn't good because they felt that they could always make it up with the rapid appreciation of the property. Now with the slow down in the housing market and the defaults that you had to expect in these lending group being more, because of the economy slowing down, these companie are in serious trouble.

In the past, bankers were basically handing out the cash to risky borrowers for home purchases. The banks were not to worried because the housing market was booming, so home prices were skyrocketing. In the event the borrower forclosed, the banks werent worried because the equity in the house was a money maker for the banks, which offset the risk. Now the housing markets are plummeting i.e.house values are decreasing, when borrowers forclose, the bank looses alot of money. multiply the bank doing this 100 times and 47% get forclosed, the bank then has lost so much money, it must declare bankruptcy. Added to this is all the interest only loans they offered to buyers. Its now time to start paying the principle as well as the interest, and people are finding they cant afford to pay, so they have to sell the house in a sluggish market, as well as finding out 20 other people on the same street did this and now all 20 houses are on the market. Good luck being the one that sells their house. It may be confussing but it is a big deal but only for a short while. To protect themselves, the banks are being more carefull on who they lend money to which they should have done in the first place so as not to put people in finnancial ruin. But as you can see the banks only care about your money, and could give a rats @ss if you go bankrupt.