Then They All Fall Down; Spreading things like U.S. mortgage risk around the world was supposed to make us safer. So why are markets getting rockier?

Byline: George Wehrfritz (With Rana Foroohar and Barrett Sheridan in New York, B.J. Lee in Seoul, Sonia Kolesnikovjessop in Singapore and Akiko Kashiwagi in Tokyo)

What does the price of a starter home in Stockton, California, have to do with the fate of European banks, or initial public offerings on the Hong Kong Stock Exchange? These days, quite a lot. Just as subprimes have tanked Asia's hottest IPO market, so they have hit German banks, global hedge funds and countless emerging market investments in recent weeks. The force that tethers all of these debacles to the growing number of Americans who can't pay their mortgages is one that increasingly sets the cadence for global commerce: risk.

Humankind has worried about risk since our prehistoric ancestors commenced bartering shells. But only in the last couple of decades has risk, by design, become a globally tradable product. As former U.S. Federal Reserve Chairman Alan Greenspan put it back in 2002, "dispersion of risk to those willing, and presumably able, to bear it" acts as a shock absorber to prevent "cascading failures," like the Great Depression in 1929. Or so goes the theory as presented by the architects of today's global financial system. Yet plenty of high-profile moneymen, including Warren Buffett and George Soros, don't buy it. They've come to view complex securitization (like the deals that bundled U.S. mortgages into bonds that were sold and resold worldwide on the thinnest of margins) with foreboding. Their concern: opaque risk dispersion, heavily leveraged and spread across global markets, can actually magnify financial turbulence by creating what Soros once called "daisy chains" of interlinked debt.

For the moment, the dispersion skeptics look prescient. Sure, money markets turned round a bit last week as central bankers pumped liquidity into the system, and the Fed raised hopes of a rate hike. But since late July, when America's subprime mess first rattled global stock markets, financial news has been mainly bad. Panic selling has raged fitfully from Stockholm to Seoul in a reaction that seemingly outweighs the magnitude of the problem. Investors wary of market volatility are shedding not just bonds linked to U.S. mortgages, but anything with the potential to fall. And everyone is looking hard to see what other shaky paper could be lurking inside their portfolios.

It's fear of those unknown daisy chains that has caused the shift. Optimists cast the three-week slide in global stocks as a needed market correction. Others aren't so sanguine. In an Aug. 15 report out of London, Credit Suisse warned that the global financial order could be on the cusp of "a system changing crash." The next day Morgan Stanley's top China strategist warned of a "fourth generation financial crisis" in emerging markets (following the Latin American debt crisis of the 1970s, the Mexican peso crisis of the 1990s and Asia's 1997-98 financial crisis) in which the U.S. economy could be "knocked into a serious recession" with global implications. The dangers of a crisis beyond today's "bad debt" problem are obvious. If the current sell-off jumps the fire-line from stocks into a wider array of other assets--pushing down, say, real estate in Europe or commodity markets currently energized by the China boom--it will become much harder to contain. And ultimately, the biggest pending issue is how plunging stock prices will affect large economies, in particular the United States, Europe and Japan (the main engines of global economic growth since World War II) as well as newcomers like China and India.

Central bankers are clearly worried. In recent weeks they've pumped a staggering $325 billion into the global financial system to brake panic selling and forestall a credit crunch spreading from home loans to other consumer debt, like credit cards. "There's a difference between subpar growth and recession," says Mark Matthews, chief Asian strategist for Merrill Lynch, which last week lowered its growth ...