In the 1960s, the Marquis of Salisbury once said of his Conservative cabinet colleague Iain Macleod that he was ‘too clever by half’. Much the same might be said of some of the modern banking fraternity. They found all sorts of complicated new ways to lend money, especially to people who really could not afford to borrow. It worked for a while, at least long enough for them to claim hefty bonuses, but now it is starting to unravel and the casualties stretch far wider than those originally involved.

When US interest rates were 1% for a year or more, imaginative new ways were developed to lend to those in the US on low incomes with poor credit histories – the ‘sub-prime’ market. When rates then rose to 5.25%, many of these over-burdened households began to default. But those caught up in the storm included German banks, French insurance companies, Japanese pension funds as well as US lenders. This is because the risky mortgage loans were parcelled up and sold off as attractive packages worth billions of dollars throughout a highly globalised financial sector as though they were as safe as government bonds. So, institutions with no involvement in the US suddenly became exposed to the risks when the sub-prime market went south and the value of the debt-backed tradable securities and derivatives plummeted.

And when things go wrong in financial markets, as they did in 1987, 1998 and 2001, the adjustment process is rarely orderly or measured. Markets have a remarkable knack of going from boom to panic without the good sense to stop off at the intermediate stage of normal and, in the ensuing chaos, many innocent bystanders get hurt. The world economy is here again, and once more the important questions are about the extent of the collateral damage. Is it likely that the irresponsible lending to the sub-prime housing market in the US will affect growth and interest rates in the UK?

Banks are in the firing line, although few will have sympathy for those financiers who lose their jobs or bonuses, or for those institutions whose profits get squeezed. No doubt there will be a widespread feeling that they will be getting their comeuppance, but this schadenfreude is short-sighted. Financial services account for around 9% of GDP and have made a major contribution to the buoyant growth of the UK economy in recent years. Anything that dents activity in the sector will impact on GDP, but current estimates suggest that the immediate effect will be to knock only about 0.1% off growth, something an economy currently growing above trend should be able to absorb without too much pain.

Of more concern are the ideas of financial contagion or a widespread credit crunch. If defaults by borrowers run to such an extent that a financial institution topples over, it could lead to panic across the industry. Equally, caution is becoming the dominant sentiment among lenders, whether they have been bitten or not, which pushes up the price of borrowing. This is what was happening to lending rates between financial institutions in the UK, as the gap between base rate and Libor (London inter bank offered rate) jumped in early September.

Both of these fears seem to be exaggerated. Banks’ balance sheets are strong enough to withstand the current losses and, assuming the worst of the news is out and the extent of the damage is known, bad debts on the current scale are part of the normal cost of doing business. Losses that would sink businesses in many other industries merely dent banks’ capital and profits.

A credit crunch would arise if financial institutions collectively adopted a safety-first approach to lending, re-priced risk and retreated to cash and ultra-safe government bonds. This would pose a threat to corporate debt, private equity and retail lending, and increases the risk of bad debts among existing borrowers. This threat has been recognised by central banks which have acted in a remarkably coordinated way to inject liquidity into the market. For once, a global issue has elicited a global response, and very quickly.

This is not to take a complacent view. Some families in the US will lose their homes, some bankers will lose their jobs, share prices will be hit, future borrowing may be harder to obtain, and so on. But this is not a financial meltdown, more a reality check for those who believed that real credit risks could be buried in complicated instruments that even apparently sophisticated banks could not identify.

The major fallout will be felt in the US where the turbulence will push the economy further downwards. And it has already brought forward the date when interest rates start to fall. The knock-on effects for the UK will be a tightening of export opportunities to the US and a slowdown in merger activity. But, since 60% of global growth last year came from emerging markets, the US is no longer the primary driver of the world economy and UK companies could, and should, be looking for export markets elsewhere.

As the Bank of England said recently, it is probably too soon to tell how badly affected the real economy will be by the financial turbulence but, so far, it looks to be manageable.