Financial markets are waking up to the unintended consequences of low interest rates, which have contributed to the Dow Jones having the "down" jones.

The widely watched market barometer dipped 2 percent on Tuesday, coming on the heels of a 3 percent drop Feb. 27. At week's end, the Dow stood at 12,110.4, down 3 percent since the beginning of the year.

Much of the market's renewed appreciation of risk can be credited to subprime mortgages and the yen carry trade, two murky markets built on easy money. Low interest rates encouraged homeowners and investors to borrow and put the borrowed funds to work.

Homeowners wanted an investment they could live in or cash for purchases they couldn't pay for with their savings. Investors hoped to capitalize by borrowing at low rates and investing the borrowed funds in higher-yielding assets.

Lately, some of their best laid plans are unsettling investors.

"Now we know the dark side of low interest rates," said John Milne of JK Milne Asset Management, a Station Square investment manager. "Globally, many financial markets are contaminated with risk."

The problem with subprime mortgages is easy to grasp. Home buyers whose credit rating is too low or who can't make a big enough down payment to qualify for a conventional mortgage arrange less conventional financing. Some of these loans feature low initial rates, don't require principal payments or don't involve rigorous scrutiny of an applicant's finances. The terms may be manageable for borrowers initially, but there can be problems when interest rates rise too much or home prices fall too far. That's where increasing numbers of borrowers and lenders find themselves today.

The Mortgage Bankers Association announced last week that 13.3 percent of homeowners were delinquent in paying their subprime mortgages during the fourth quarter vs. a 5 percent delinquency rate for all types of mortgages.

"Payments are late or in default at a time when employment is strong. This is a conundrum for the marketplace," Mr. Milne said.

Problems at New Century Financial and other subprime lenders unsettled the market last week as investors worried how much of the problem would splash onto Wall Street firms, banks, pension funds and other players involved in mortgage backed securities -- packages of subprime mortgages bundled together and sold to investors seeking high yields in a low interest rate environment.

The problem also could affect Wall Street firms and others that issued credit default swaps, basically insurance for investors in case their bundles of mortgages go sour. The swaps made mortgage backed securities appear to be less risky than they really are, says Jack Kunkle, an analyst with Pine money manager Muhlenkamp & Co.

Despite its imposing name, the yen carry trade isn't all that complicated. Once U.S. rates started rising, sophisticated investors playing the spread on rates they could borrow at and rates they could earn on their borrowed money turned to Japan, where money was still available at about 1 percent.

Just how many investors were doing this, how much they borrowed and where they invested isn't clear. Market observers believe that a good deal of the borrowed yen went into U.S. Treasuries, but some of it may have made its way into China's stock market, subprime mortgages and other investments.

"It's hard to find numbers on any of this stuff. It's so easy to engage in financial alchemy at this point that you just don't know what the players are doing," said Colin Symons, chief investment officer for Symons Capital Management in Castle Shannon.

The outcome of arbitrage is determined by the return on a yen carry trader's investment and the value of the yen. A decline in the value of their investment or a rising yen will undermine or eliminate their profits.

Mr. Symons says that, over time, borrowing a lot of yen and converting it to U.S. dollar-denominated investments should increase the value of the yen, eventually eliminating the potential for profit. He says a temporary rise in the yen helped trigger the Dow's 416-point decline last month. But so far, the Japanese currency hasn't risen in value against the dollar even though economic theory says it should.

The yen-dollar disconnect hasn't escaped the notice of Joe Balestrino, senior portfolio manager for Federated Investors. "What's going on today has almost zero to do with the fundamentals," he said.

Mr. Balestrino says the low interest rates of the last few years basically paid investors to take risks, a proposition that can't last forever.

"That's not a sustainable thing in the investment world and eventually it breaks," Mr. Balestrino said. "This is a wake-up call we're going through here -- probably a healthy one."

The potential consequences include reduced consumer borrowing and spending, a weaker economy and tougher standards for qualifying for a new mortgage or refinancing an existing loan. The economic challenges are sure to provide plenty of fodder for the 2008 presidential campaign, although it remains to be seen whether a solution more enduring than low interest rates will make it onto the agenda.

"The long-term bet on the economy is that we have to do things differently," Mr. Symons said. "We have to come up with productive things to stimulate our economy because debt isn't going to do it anymore."