STOCK markets on both sides of the Atlantic tumbled last night on growing fears that America's two biggest mortgage companies will have to be bailed out by the US taxpayer.
In London, the benchmark FTSE 100 index slumped almost 3 per cent to close at 5,261.6, wiping more than 34 billion from the value of Britain's largest companies.
It left the index firmly in "bear market" territory – defined by a fall of 20 per cent or more from last June's peak of 6,732.
Sentiment was also hit by oil prices soaring to a new record high above $147 a barrel.
US markets slumped as concerns grew over the future of mortgage giants Fannie Mae and Freddie Mac, with the Dow Jones industrials sliding below the 11,000 mark – a fall of more than 2 per cent – for the first time in two years.
Investors are concerned that the two mortgage firms might run short of capital, placing the fragile US economy at even greater risk of a protracted recession.
It had been thought that the US government may step in to rescue the pair, but US Treasury secretary Henry Paulson yesterday said the primary focus was supporting them "in their current form as they carry out their important mission".
Together, Fannie Mae and Freddie Mac hold or guarantee some $5 trillion (2.5tr) worth of mortgages, roughly half the mortgage debt in the US, but concerns have mounted over the strength of their finances to cope with rising arrears in a housing market slump.
CMC Markets sales trader Adam Seagrave said: "The state of the US financial sector is on the watch-list for many with the health of Fannie Mae and Freddie Mac dominating, along perhaps with concern over the outlook for Lehman Brothers."
Shares in the two mortgage firms fell sharply as did those of Lehman Brothers as concern grew about the US investment bank's fate after it said hard-to-value assets now make up a higher percentage of assets.
Phil Orlando, chief equity market strategist at Federated Investors, said: "You have two issues. Crude (oil prices] popped back up $10 to $11 in the last few days, and that is causing some concern.
"The second point is the financial services sector. There is concern and speculation that Freddie, Fannie and Lehman won't be around on Monday. That's obviously causing worry."
Meanwhile, General Motors chief executive Rick Wagoner moved to reassure investors over the financial health of the world's biggest carmarker as bankruptcy fears continue to weigh on its shares.
Wagoner said GM had cash and unused credit facilities amounting to some $30 billion.
As the London market hit its lowest closing level in nearly three years, banking shares were the biggest losing sector on the Footsie.
Royal Bank of Scotland dived 8.6 per cent to a multi-year low of 182.7p, while HBOS, with a 4bn rights issue pending at 275p-a-share, fell 1.8 per cent to 266.5p.