Dominoes

So who is next? As advisers to Bear Stearns struggle to find a buyer or funding in the next 28 days, Wall Street, the City and the financial district in Tokyo were scrabbling to find out who is the most exposed to Bear Stearns, either through loans or trading positions.

Traders in all three centres were panicking even for those banks not directly exposed to Bear. They feared that the problems experienced at the stricken bank signalled that the credit crisis has deteriorated to a new level.

Yesterday, traders began to look anxiously at the robustness of Lehman Brothers, which, although bigger than Bear, is small compared with JPMorgan Chase, Morgan Stanley and Citigroup.

Shares in Lehman dropped 11 per cent yesterday, a far bigger fall than its other rivals, which saw their stock decline by about 3 per cent.

Although Lehman is more diversified than Bear, it has a similar investment profile, with huge holdings in mortgage-backed debt. Lehman sought to reassure the market when it said yesterday that it had secured a $2 billion (£1 billion) credit line with Paolo Tonucci, the bank’s global treasurer, calling it “a strong signal from the market and our key bank relationships”.

However, Chris Whalen, of the Wall Street consultancy Institutional Risk Analytics, said: “This is going to go all the way up the chain. There is a risk that all broker dealers are going to become an endangered species if the credit crisis is not sorted out. If they can’t fund themselves, they will have to shrink. All the other firms are in danger, too.”

He said that should the US Federal Reserve, the US Treasury and the Securities and Exchange Commission not devise a broad rescue plan to address the credit turmoil on Wall Street this weekend, “I would not be surprised to see an emergency bank holiday announced. That hasn’t happened since Roosevelt.” During the Depression, 75 years ago almost to the day, Franklin Roosevelt declared a four-day bank holiday, which stemmed a frantic run on banks. Mr Whalen added that should banks such as Lehman continue to be unable to sell the billions of dollars of mortgage-backed securities held, they were doomed. He said: “Broker dealers have to be able to get rid of assets. If they are illiquid, they die.”

Over the past ten years, global banks increased their issuance of mortgage-backed securities to feed a growing appetite for what investors believed were high yet stable yields. In 1998, banks issued $16.4 billion of the securities, according to calculations by Thomson Financial. By last year, the issuance figure had ballooned to $366 billion. Issuance so far this year is $4 billion.

The Royal Bank of Scotland was the world's biggest underwriter of mortgage-backed securities last year. An underwriting bank takes responsibility for selling the securities into the market.

RBS underwrote $44.7 billion of securities, taking a 12 per cent share of the market. Bear Stearns was the eighteenth-largest underwriter in 2007, underwriting $6.3 billion of the investments.

Fears of a UK financial casualty were also alive in the Square Mile, with banking stocks among the biggest losers on the stock market yesterday. HBOS, the UK’s biggest mortgage bank, led the sector down as the FTSE 100’s biggest faller, dropping more than 6 per cent to 528p a share, while Barclays closed down almost 5 per cent at 433p. Their shares fell even though British banks have tiny exposures to the American mortgage market in comparison with the big US and European investment banks.