US Subprime Mortgage Crisis Causes Lurches on Wall Street

America's sub prime mortgage crisis caused nervous lurches on Wall Street yesterday as two leading home loans companies suffered a crisis in investor confidence and the Federal Reserve dampened economic expectations.

Shares in America's biggest mortgage lender, Countrywide Financial, dived by 22% at one point on rumors of bankruptcy, prompting the firm's management to issue a hurried assurance that it had "ample liquidity and capital".

The sell-off came hours after the government-sponsored mortgage guarantor Freddie Mac revealed that it was in danger of breaching minimum liquidity requirements after an $8.1bn drop in the value of its assets, prompting its stock to collapse by 29%. On a day of severe volatility, the Dow Jones Industrial Average dropped by more than 100 points at one stage before closing down 51 at 13,010.

As economists continue to debate whether the credit crunch will lead to a recession, the Federal Reserve released long-term forecasts which scaled back expectations for economic growth next year while playing down the prospects of lower interest rates.

Minutes from the Fed's October meeting called the recent cut in rates a "close call". The central bank predicted growth could slow next year to 1.8% - significantly below the range of between 2.5% and 2.75% envisaged in June.

After a steady stream of red ink, write-downs and losses from major financial institutions, concern is mounting about the true extent of the liabilities of some of America's biggest lending operators.

Countrywide, which provides one in seven US mortgages, has already disclosed $1bn in losses but was hit by a downgrade yesterday by analyst Howard Shapiro at stockbroker Fox-Pitt Kelton, who headed his note: "The lifeline is withdrawn."

He argued that Countryside's main route to passing on loans could evaporate due to problems afflicting Freddie Mac and Fannie Mae - the twin companies established by the US government to promote home ownership by purchasing mortgages, repackaging them and selling chunks on the capital markets. He described Freddie Mac's position as "as bad as it could possibly be".

Freddie Mac revealed a $2bn quarterly loss, a $1.2bn provision against bad loans and an $8.1bn drop in the value of its assets. It said it was considering slashing its dividend to shareholders by 50%.

In a sign of scale of its difficulties, Freddie Mac has called in Goldman Sachs and Lehman Brothers to advise it on "very near term capital raising alternatives". It said its core capital of $34.6bn was just $600m above the 30% mandatory target for its financial surplus directed by the US government.

Freddie Mac's chief executive Richard Syron said the company was taking "aggressive, forward-looking and financially prudent" steps to meet its responsibilities.

Speaking on a conference call, he was pessimistic about the economic outlook: "We do not believe it would be wise to be sanguine about the medium-term housing market."

The prevailing gloom was in spite of an unexpected bounce in construction, as the US Commerce Department reported that work commenced on 1.229m homes during October - a 3% rise on September's figure.

Although the increase was the biggest since February, the strength was largely in apartments. The all-important category of family homes showed a continuing decline, as did the number of future building permits which fell 6.6% - indicating a weaker long-term trend. The jury is still out on the impact of the housing crisis on high-street spending. Target, a cut-price retail chain, yesterday revealed a 4.5% drop in profits, blaming a weakening in demand for higher margin goods such as clothes.

But a positive picture emerged from retailers catering for more affluent shoppers. The luxury retailer Saks - which sells brands such as Gucci, Prada and Burberry - said its quarterly profits had tripled to $21.6m as women continued to buy handbags, shoes and jewelery. Its figures came hot on the heels of a 22% jump in profits from the department stores chain Nordstrom.