US house prices posted their steepest fall in 20 years in the second quarter of the year, plunging 3.2 per cent, according to figures released today.

The drop was the steepest since Standard & Poor’s began its nationwide housing index in 1987.

Falls in house prices now look set to continue as defaults on mortgages rise as a result of the increasingly lax lending practices employed until recently.

House sales are also expect to decline as potential buyers find it increasingly difficult to secure mortgages, with lenders reeling from losses on high-risk sub-prime home loans and related investments.

The latest bearish data sent London stocks sliding and Wall Street down almost 100 points.

Earlier this month, the US Federal Rerserve was forced to take the highly unusual step of cutting the rate charged to lend to banks at its discount window from 6.25 per cent to 5.75 per cent.

The central bank aims to boost liquidity by eliminating the stigma attached to these loans, traditionally seen as a sign of a borrower’s weakness, and encouraging banks to use the facility.

Market sentiment took another knock today after Merrill Lynch downgraded the Wall Street giants Citigroup, Lehman Brothers and Bear Stearns.

Last week it had appeared that America’s beleaguered housing industry had been given temporary respite. New data defied expectations and revealed a rise in new home sales in July, giving the Federal Reserve a much-needed boost in its campaign to steady the markets.

Sales of new, as opposed to existing, homes increased by 2.8 per cent in July, from the month before, to an annual pace of 870,000, according to the Commerce Department. This was well ahead of the 820,000 consensus analysts’ estimate, which would have marked a seven-year low.

Analysts said that financing for most of last month’s home sales would have been arranged before the full extent of the credit crunch came to light in the second half of July. They expect sales to deteriorate significantly in the face of declining house prices and tightening credit markets.

Bank of America has been forced to inject $2 billion into Countrywide, the US sub-prime mortgage broker, in an attempt to avert bankruptcy at a company previously seen as one of the country’s safest mortgage groups.

That all changed when Countrywide struggled to raise short-term debt, known as commercial paper, and was forced to tap its entire $11.5 billion credit line.

Bank of America’s cash injection came hard on the heels of announcements that Lehman Brothers had closed its sub-prime lending unit with the loss of 1,200 jobs and Accredited Home Lenders had ceased new business, making 1,600 staff redundant. Meanwhile, HSBC shut its 600-staff home loans office in Indiana.

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