Bear Stearns hit by downgrade fears as mortgage fallout widens

Bear Stearns, the troubled investment bank, is locked in a war of words with the credit rating agency Standard & Poor's, amid the widening financial impact of the US mortgage crisis.

Shares in the US collapsed in the final hours of trading yesterday, with the Dow Jones falling 281 points to 13,182.

S&P yesterday said the outlook for Bear Stearns debt was "negative" - rather than "stable", as it had said before - indicating to investors that the credit rating on the company's bonds could be downgraded soon.

The move came after two Bear Stearns-run hedge funds went bankrupt and another suffered huge losses as a result of turmoil in the mortgage market that shows no signs of abating. American Home Mortgage, one of the country's biggest lenders, shut up shop yesterday, laying off almost 7,000 workers after its banks withdrew their support.

And across the US, lenders were demanding higher interest rates on new mortgage loans and refusing credit to the poorest Americans, actions threaten to exacerbate the housing market slowdown which triggered the crisis in the first place.

Bear Stearns reacted angrily to S&P's comments. "The specific concerns over issues relating to certain hedge funds managed by Bear Stearns are unwarranted as these were isolated incidents and are by no means an indication of broader issues at Bear Stearns," the company said. The bank held an emergency conference call last night to try to reassure investors.

The issue is important because a lower credit rating will make it more expensive for Bear Stearns to raise money, which will cut revenue and profits at a bank which has been one of the biggest players in debt markets in recent years.

Because mortgage lenders sell the mortgage debt immediately in the financial markets, US homes are used as collateral for debt instruments across the financial system. These instruments have fallen in value, though, because of falling house prices and rising mortgage defaults.