As the fallout continues in global financial markets, fears are rising that another global crisis might be on the horizon. Markets and central banks appear to be engaged in a tug-of-war. For a poor, heavily indebted country like Jamaica, the result could be painful.

At issue is the deflation of the latest bubble in the US, that in housing. Itself a product of US monetary policy, the housing bubble saw real estate prices driven sky-high by cheap credit and loosened lending standards. Prospective home-buyers who would never have before qualified for mortgages were given loans without having to put up deposits; often, they paid only interest for the first few years.

With 'subprime' borrowers coming on to the market, risks were high. Normally, higher risk translates into higher interest rates, as lenders demand a premium. However, lenders bundled together these loans, backed them with bonds, and sold the bonds to hedge funds with diversified portfolios. By thereby spreading risk, mortgage companies were thereby able to keep offering abundant credit for dubious investments.

It was like diluting dirty water in a clear lake. The problem is that while the dirty water seemingly disappears, the whole lake has grown polluted. And because nobody has an incentive to stop dumping, the lake grows ever more toxic.

Bust inevitable

Cheap credit eventually drove housing prices so high people stopped buying. A bust was inevitable. But the conventional wisdom was that the housing bust would not be like the stock-market crash of the late 20th century.

When overvalued share prices fall, investors will sell to recoup their losses - especially when they are heavily indebted, as Americans had become. This drives assets into a downward spiral. However, it was said that because homeowners lived in their assets, they would not walk away from them. Complicated models measured the risk of an asset meltdown, and judged it low. It was this confidence that encouraged financial institutions to buy up the "securitised" packages of bonds that guaranteed cheap credit.

However, the models were based on outdated assumptions. In the days when home-buyers had to make deposits on their purchases, they obtained equity in their homes, which they did not want to lose in a foreclosure. But today, a homeowner, whose house is worth less than his or her mortgage, and who borrowed all the money to buy it, has no incentive not to walk away.

House prices plunging

Apparently, that is what is happening in the US. As Americans abandon their homes, house prices are plunging. But rather than worsening the balance sheets at the banks and mortgage companies alone, the spread of risk is hurting virtually all financial companies - not only in the US, but everywhere the securitised investments had become popular in the 1990s. And, as these companies' balance sheets grow worse, their risk management models require them to sell assets to maintain liquidity. Hence, asset prices spiral downwards.

To try and prevent a fully-fledged crash, the US Federal Reserve is pumping cheap money into the banking system. But this is feeding the next bubble - commodities. Oil prices rocket as speculators lose confidence in traditional asset classes and seek 'hard' assets. Higher commodity prices and a declining dollar are thus worsening US inflation. This creates a vicious cycle in which investors, losing confidence in the Fed, are fleeing just about all assets but US Treasury paper.

Not only are import prices rising for countries like Jamaica, but so too might yields on government bonds. So the pain is spreading. And until Americans are prepared to suck up the cost of their bubbles and accept a temporary downturn in their markets, we'll all share the pain.