Markets dive on fresh credit crisis fears

The FTSE 100 plunged back towards the lows it reached when the credit crisis first emerged in the summer, caught up in a worldwide sell-off on equity markets and fears of solvency problems throughout the global banking system.

In the UK, tens of millions of pounds were wiped off the value of mortgage lenders such as Northern Rock and Alliance & Leicester, while, on the other side of the Atlantic, Citigroup shares fell after a rival bank suggested it could be forced into a rescue fundraising or a fire sale of assets.

Reflecting a sharp slide on Wall Street, selling in the UK accelerated through yesterday afternoon and the FTSE 100 fell 170.4 to 6,120.8. That is its lowest since 21 August, when fear of losses related to US mortgages paralysed many parts of the credit markets.

Despite $50bn (£24.4bn) of write-downs on mortgage-related securities across the global finance industry, investors still fear more to come and banks have again become more cautious about lending to each other. The closely watched UK inter-bank interest rate, three-month Libor, was yesterday up to its highest level in two months, after a seventh straight session of gains.

"There is a problem of confidence because all the bad mortgage debts have been spread around like a virus," said Kevin Logan, US economist at Dresdner Kleinwort. "It is like the turkeys in the UK. The only thing to do is to draw a five-mile exclusion zone and kill all the turkeys. Even if only a few of them ever had the bird flu virus, you have to prove to everyone that the problems have been isolated, quarantined and dealt with. Only then we can go back to eating turkey again."

Analysts and investors on both sides of the Atlantic are nervously anticipating where the next problems may emerge.

Northern Rock shares fell more than a fifth to reflect lower-than-hoped-for bids for the stricken lender, and Alliance & Leicester dipped 25.5p to 581.5p at the end of a day when it had to quash rumours it has sought emergency funding from the Bank of England. It said it has been funding its operations as normal in the financial markets, and had not been forced to pay an interest rate significantly higher than Libor.

Citigroup, which has had to pay a higher interest rate to raise funds in the financial markets in recent weeks, was among the worst performers on the Dow Jones, thanks to a sell recommendation by Goldman Sachs. In a research note published yesterday, analyst William Tanona said Citigroup, the largest financial institution in the US, will fall $4bn short of its solvency targets for next year. As a result, it could be forced to choose between a dividend cut, asset sales or a rescue refinancing that would dilute existing shareholders.

"Citigroup is less well capitalised than other large US banks ... and achieving its target ratios may be more challenging given the state of the credit markets," Mr Tanona wrote. "We are getting increasingly uncomfortable with its near-term prospects."

Last month, Citigroup suspended its share buy-back programme as it worked to shore up its balance sheet in the wake of $3.8bn of losses on mortgage-related securities, credit derivatives and other loans. Goldman Sachs predicted a further $15bn in write-downs over the next sixth months, more than Citigroup's current estimate of $8bn-$11bn, because of the deteriorating demand for credit products backed by US mortgages.

The Dow shed 218.4 to 12,958.4, and interest rates on US Treasuries were at two- and three-year lows as investors fled for the relative safety of such government bonds. Countrywide Financial, the largest mortgage lender in the US and a key player in the market for sub-prime loans to low-income Americans, fell 10 per cent to its lowest in more than five years as worries resurfaced over how it will finance its ongoing business. General Motors shares plunged 9 per cent on fears for its GMAC mortgages and car loans business.