Led by bank stocks, billions of pounds were wiped off market values. Many European exchanges sank to new lows for the year, with some analysts beginning to point to a scary resemblance to the 1929 Wall Street Crash.
"I'm half frightened and half bearish," said Barton Biggs, chief global strategist at Morgan Stanley Dean Witter. "There is still a chance that we'll have a rally that is going to last a couple of weeks and take us up 5 to 10 per cent. But then we could plunge into the abyss."
The worst-hit market was Lisbon, which had to halt stock trading for two hours after shares dived 15 per cent in what was described as panic selling.
US stocks took another beating, with the Dow Jones index closing down 210 points at 7,632, only 100 points above where it stood after the 512- point plunge of 31 August.
Economic data suggested some weakening in the US economy, and corporations are cutting their profit forecasts, but but the real reasons lie in much wider fears about financial stability. Banks and technology companies took the brunt of yesterday's fall, with the technology-intensive Nasdaq composite index down nearly 5 per cent.
The Federal Reserve disappointed financial markets with the size of a cut in interest rates on Tuesday, reducing only by a quarter point when a half point had been expected. The US has room to cut rates further, by as much as another three-quarters of a point, the IMF said on Wednesday. But the Fed is apparently keeping its powder dry for rate cuts later this year.
Notes from the Fed's August meeting show that it was only a month ago that it changed from a position of favouring an interest rate rise to a neutral stance, where either a rise or a cut was possible. Even then there was one dissenting voice.
Before he signalled a cut in Congressional testimony last week, Mr Greenspan held a telephone conference call with his Fed colleagues to discuss the issue. The call came the day after the Fed had announced that it had jumped in to co-ordinate rescue of Long-Term Capital Management, the hedge fund which came close to collapse.
That event seems to have crystallised fears about credit conditions. A Fed survey released yesterday showed that bank lending for corporations has tightened markedly in the last month. "Results indicate that there has been a fairly widespread tightening of standards and terms for commercial and industrial loans to larger firms," the Fed noted. It cited "less accommodative financial conditions" as one reason for Tuesday's interest rate cut.
Banks are being squeezed as bond prices shoot up and yields come down, leaving the yield on a 30-year US Treasury bond yesterday at another record low. There are also concerns about the continuing effect of the collapse of LTCM. Bankers Trust yesterday indicated in a filing with the Securities and Exchange Commission that it has $850m in hedge fund exposure, all of which is collateralised in cash and US Treasuries.
In London the FTSE 100 index closed more than 3 per cent lower at 4,908. The latest purchasing managers survey showing manufacturing activity declining for the sixth successive month added to the gloom. The index now stands at 20 per cent below its July peak.
In Tokyo, the September Tankan survey of industrialists showed business confidence at a four-year low, sending the Nikkei reeling 209.27 to 13,197.
Continental bourses fared even worse than London, with the main Frankfurt and Madrid indices showing falls of 7 per cent or more.
The grim news continued, with ING Barings cutting its 1998 earnings forecast and axeing 1,200 of its 9,000 staff worldwide. Around 40 of the jobs lost will be in London.
The Bank of Italy then admitted an investment of $100m in Long-Term Capital Management. The bank said it had also lent a further $150m.
Dresdner Bank shares fell after an informal briefing from its chief executive, Bernhard Walter, warning that market turmoil would hit third-quarter earnings. Dresdner is one of the European banks that invested in Long- Term Capital before the fund had to be bailed out.
Bonds continued to be one of the few safe havens in the financial tempest. British gilt edged stocks hit record highs for the second day in a row.Reuse content