The dire event that many have been warning about for years is finally unfolding as the long-anticipated US sub-prime market problems move to a contagion phase.

There are three main takeaways from the market weakness and instability we are witnessing.

The first is that it should put to rest the view of many market commentators who have been keen to dismiss the impact of what happens in the US on equity markets globally. The US consumer and specifically the US consumer’s mortgage remains the single most significant component of the global economy and no amount of infrastructure spend in China or India will alter that reality for the foreseeable future.

The second is that this is not another Amaranth-style event. Amaranth was the US$9b hedge fund which blew up last year, caused concerns about driving another Long Term Capital-type market meltdown event before the market moved onto new record highs.

Some commentators are optimistically comparing this current market weakness to that event. It is a flawed and dangerous comparison. Why?

Amaranth blew up because one trader made one very wrong bet. The markets are blowing up now due to a systemic problem which has emerged in US debt markets and which involves the entire financial services value chain from the consumer with a poor credit history to the investment bank putting together structured debt products to the hedge fund manager borrowing money to buy debt securities.

In other words we are witnessing what leverage upon leverage upon leverage gets you when one part of that chain breaks down. This brings us to the bad news.

The bad news is that the Standard & Poor’s/Case-Shiller Home Price Index of 10 US metropolitan areas is showing a year-over-year decline in house prices of 3.4%. To quote Robert Shiller “At a national level, declines in annual home price returns are showing no signs of a slowdown or turnaround.”

That means that unless this trend is reversed the sub-prime market can deteriorate further and Ben Bernanke’s comments about sub-prime losses being limited to US$100b may become the central banker equivalent of George Bush’s Mission Accomplished banner.

The markets may well stabilize this week or next week as some focus returns to strong global growth but the sub-prime mess is not going anywhere. It’s going to get worse and it’s only a question of how much worse it will become.

PS The Financial Review, always on the ball. Today, it has a special lift out report pushing for it… leveraged equities. Nothing like timing. And the ad department and editorial working hand-in-hand.