Pain was felt throughout world financial markets, and casualties cropped up in the most surprising of places - from powerful global banks to penny-stock investors.

Just last Wednesday, ordinary investors from Toa Payoh to Raffles Place watched in horror as $22 billion was wiped off the value of Singapore's share market in one day.

The same dramatic sell-down was played out from Sydney to Seoul.

By now, every other person will tell you who, or what, to blame for the stock-market bloodbath - the souring US subprime mortgage market, of course.

What is not clear is how an American subprime borrower - basically someone with a bad credit history - can end up being the problem of investors several time zones away.

After all, investors will not knowingly bet their hard-earned money on the likelihood that some faraway stranger with no income will repay his home loan in the US.

Or will they?

What has 'subprime' got to do with me?

A CLOSER examination of the subprime mess reveals a tangled web of complex deals where the risk of US subprime delinquencies has been passed on around the world.

And some people and institutions bearing these risks are doing so more knowingly than others.

In the few years to 2006, the US property scene was red hot.

Thanks to exceptionally low official interest rates, loans flowed freely to individuals to invest in homes.

A group of these borrowers were 'subprime' ones who managed, in those heady days of easy money, to get loans with little proof that they could pay it back.

Banks and finance houses covered the risks of lending to these people with poor credit history by charging higher interest.

Last year, at the peak of the housing boom in the US, 21 per cent of total US mortgage lending was to subprime borrowers.

When the bubble started to deflate, a number of American lenders specialising in mortgages folded as defaults soared.

The link here is obvious: When the previously booming American property market headed south, companies which recklessly lent to Mr and Mrs Not-So-Credit-Worthy lost money.

But the nightmare does not end there.

A game of pushing risk to others

IN RECENT weeks, big banks worldwide, such as Britain's HSBC and Germany's IKB, hit the headlines after they revealed that they, too, have billions of dollars worth of exposure to the crisis-hit US mortgage market.

Smaller banks, hedge funds and other institutional investors suddenly find themselves being quizzed about whether they have 'subprime exposure' or hold 'collateralised debt obligations (CDOs).

It turns out that some lenders who made subprime loans are no longer at risk when people default, because they have passed on those risks.

When subprime delinquencies soar, trouble turns up somewhere else, on someone else's books.

What has happened is the ballooning of financial instruments that let investors bet on the likelihood of loans being repaid.

Essentially, by a stroke of clever financial engineering, subprime loans can be pooled together, repackaged and the best 'slices' sold to investors as high-yield bonds.

CDOs are a fancy name for bonds backed by a group of loans or other bonds.

While no sensible person would go near assets honestly marketed as complicated bonds backed by risky home loans, it turns out that if a sophisticated name were to be slapped on them, there may be buyers.

Given that a CDO bundles up different bonds and loans, companies and funds who buy these complex investments - and banks who lend them money to buy them - may not understand how much subprime risk actually sits in their hands.

Retail investors in such companies and funds may then be indirectly exposed to these risky loans.

The Monetary Authority of Singapore, which regulates the financial industry here, last week asked Singapore banks to keep assessing their exposure to the subprime mortgage market and 'take appropriate action if necessary'.

Investment-grade credit ratings

MUCH of the subprime-related CDOs held by institutional investors carry stellar grades by credit-rating agencies - meaning the risk of default is minuscule.

How did a bunch of shaky home loans end up becoming investment-grade material?

One way was by dividing the bonds into slices.

Certain slices have priority when it comes to getting repaid and so are considered relatively 'solid' investments.

However, as US mortgage delinquencies surge, the already slim chances of subprime repayment are being reviewed, and their related bonds along with them.

What this means is the value of subprime-related assets may be lower than initially thought.

As a result, after the first ripples of financial shock from the debacle were felt over the past week, there could be a second, longer-lasting wave of impact coming.

It is this second wave that is spooking share markets globally: the spectre of an economic downturn as banks become so wary of risks that even money to fund good investments dries up.

The liquidity party ends

LOOSE monetary policies worldwide have, in the past few years, flooded asset markets with liquidity or easy cash at low interest rates.

This 'liquidity party' has lifted share and property prices in numerous countries, including Singapore.

It has also fuelled expensive buyouts of corporations by private equity firms, which could borrow much more from banks than the capital they actually own.

Up till recently, investors have been asking for very little in return for taking risks.

But the day of reckoning for indiscriminate lending has arrived, and with it, reduced appetite for risk and less fervour for lending freely.

When credit conditions turn, a lot of otherwise sure-fire investment strategies would become wobbly.

How many billion-dollar buyout deals will sour as a result?

In the next few weeks, more faraway casualties of the subprime debacle will no doubt surface, as it becomes clear just who is really holding these risks.

ericatay@sph.com.sg