Moody's Investors Service cut its ratings on $5.2bn of bonds backed by sub-prime home loans last week, and put a further $5bn of CDOs on review.

Standard & Poor's lowered its assessment of $6.39bn of debt, after earlier putting the figure at $12bn (which suggests S&P should spend some of its fees on new beads for the office abacus).

The two assessors should scrap every appraisal on the sub-prime portion of the $503bn of CDOs sold globally in 2006, according to Mehernosh Engineer, a London-based credit strategist at BNP Paribas.

Because people were able to borrow money without credit checks in last year's freewheeling mortgage market, the rating companies have no right to use inductive reasoning to predict the likely defaults on sub-prime CDOs.

"Their models are unable to predict any 'normal' behaviour due to this overriding fraud factor, " Engineer wrote in a research report last week.

"The right thing for the rating agencies to do for the 2006 vintage would be to withdraw all ratings."

In Nevada, lenders have foreclosed on the mortgages of one in every 175 households, according to figures released last week by Californiabased data company RealtyTrac. The total number of US properties in foreclosure . . . typically those more than 90 days behind in mortgage payments . . . climbed 87% in June from a year earlier, reaching one per 704.

Mark Zandi, chief economist at Moody's Economy. com, told CNNMoney. com that a record $50bn of adjustable-rate mortgages will reset at higher levels in October. A borrower who got a $200,000 mortgage in 2005 at 4% has been paying $955 a month; that will soar to $1,331 after the reset.

No wonder RealtyTrac is predicting that more than a million borrowers will join the 761,343 already facing foreclosure proceedings this year.

Contagion from the allegedly selfcontained implosion in the US subprime mortgage market is drifting through the securities industry like mustard gas. It helped push the dollar to a record low last week, triggered the biggest deterioration in European corporate-bond risk in at least three years, and drove an index that tracks leveraged-buyout loans to a ninemonth low.

In the equity market, the Chicago Board Options Exchange Volatility Index has averaged 17.57% this month, up from 12.56% in the first quarter and 12.81% for 2006.

The S&P 500 Index has gained 0.6% in the month to 11 July; its sub-index of 92 financial stocks has dropped 3.6% as shareholders fret about how much the banking industry stands to lose for lending to the hedge funds that bought all of those CDOs. Bear Stearns Cos, which runs two hedge funds that almost collapsed last month, is down almost 7%.

For now, nobody knows how high the losses on bonds backed by US sub-prime mortgages might rise:
"$52bn, " says Credit Suisse Group; "$75bn, " suggests Pacific Investment Management Co; "$90bn, " counters Deutsche Bank.

The bigger unknown is whether the ripples will spread from financial markets into the broader economy, as stricter lending standards reduce the flow of cheap money that has been keeping global growth afloat.

"The incremental risk aversion now evident in the financial markets seems to us to be a sign that the financial liquidity spigot is starting to tighten, " Richard Bernstein, chief investment strategist at Merrill Lynch & Co in New York, said in a research note. "The childhood alliteration to remember how to turn a spigot is 'righty-tighty, lefty-loosey'.

It's now righty- tighty time for the financial markets."

The iTraxx Crossover Series 7 Index, which tracks the creditworthiness of 50 European companies in the credit-default swap market, soared as high as 310 basis points, from 260 basis points earlier in the week and from as low as 188 at the start of last month. The higher the index, the more costly it is to insure your bond investments against rising defaults.

Global credit markets face what fund manager Gary Jenkins calls "a Kerplunk moment", referring to the children's game in which players withdraw skewers while trying not to dislodge 32 marbles suspended in a plastic tube.

"Volatility to the markets is like a toy to a five-year-old, " says Jenkins, who helps manage $650m of bonds and derivatives at Synapse in London.

"Your little darling really wants that toy. Then she leaves it in a corner and goes off to play with something else.

When it isn't around, we all want it, but when it gets here, we really don't want it at all."

As S&P and Moody's work their way through the gazillions of CDOs they have assigned credit gradings to . . . last year's $503bn of new securities compared with $274bn in 2005 and just $144bn in 2004 . . . further rating cuts seem inevitable.

"If all the marbles fall, you lose it all!" went the pitch for Kerplunk, first sold by the Ideal Toy Co in 1967 and later marketed by Mattel. "You're only sunk if they go KerPlunk!" Those central bankers who have wondered how the brave new financial world of hedge funds and derivatives would cope in a crisis may soon have an answer. Let's hope it's not "KerPlunk".