It’s arguable that falling house prices in themselves are not bad for the economy as they are moving back to a more realistic price level, however it’s the falling house prices that are damaging the books of the banks due to the fact they are on the books at the higher price in the form of derivatives and loans. This means as house prices fell the loans and derivatives became less valuable and so banks had to restrict lending to keep to the required capital levels they need to survive. This led to some banks that needed to borrow money over a short period not being able to and so collapsing due to lack of short term capital, this then led to banks holding onto there money for fear of this happening to them and hence it was even more difficult to get a loan. To add to this banks all insure each others books using derivatives as insurance systems, so for example natwest might agree to pay out a sum to royal bank of scotland if a certain bond suddenly plummeted in value, in exchange for t