Market is shaken by warning on sub-prime crisis

The sub-prime mortgage crisis in the US continued to cause turmoil in bond markets yesterday, as traders feared new waves of losses among holders of debt backed by risky home loans.

The value of debt backed by sub-prime mortgages collapsed to a record low as investors digested an admission by Bear Stearns that two of its hedge funds - which just a couple of months ago had $20bn (£9.7bn) invested in the market - were now virtually worthless.

Rumours swept the markets that hedge funds at a second Wall Street bank were also in trouble, and Lehman Brothers was forced to make a public denial to calm skittish investors. Nerves had been frayed all day, since Bear Stearns' admission, in a letter to clients on Tuesday, suggested that other banks will have to follow suit and admit that their sub-prime mortgage-backed assets are not worth what they claim.

JP Morgan Chase, the financial giant which owns one of the biggest high street banks in the US, tripled its reserves against defaults from its mortgage borrowers, a move that underscored how rising interest rates have crippled homeowners who took on large mortgages. The effects have been felt most keenly by so-called sub-prime borrowers, those Americans with the weakest credit ratings.

Their loans have been sold on, repackaged, sliced up and sold on again in pieces to Wall Street's hedge funds, so rising defaults by the original borrowers are cascading through the financial systemreducing demand.

The imprecise, but widely followed, ABX index of mortgage-backed debt fell to a record low at midday trading yesterday, and the part of the index which tracks the riskiest bonds has more than halved since the start of the year. Even the part of the index which tracks slightly less risky bonds has fallen sharply in recent days, reflecting the absence of buyers that has forced Bear Stearns to admit its holdings are worthless.

"In light of these returns, we will seek an orderly wind-down of the funds over time," Bear Stearns wrote. The hedge funds' manager Ralph Cioffi, the 51-year-old Bear Stearns veteran, who has seen his reputation shattered by the funds wrong-headed bets, is still with the firm. Rich Marin, head of Bear Stearns asset management division, was replaced at the end of last month.