A £12bn takeover of Britain's biggest lender, HBOS, failed to halt the deepening crisis in world financial markets last night, as a wave of fresh speculation on global stock markets saw two of Wall Street's most prestigious investment banks targeted as the latest victims of the credit crunch.
On a day of frenetic activity and unfolding drama, shares in the City fell for a third day and Wall Street had a steep decline, despite attempts to restore calm through the takeover of HBOS by Lloyds TSB and the nationalisation of the US insurance giant AIG.
The FTSE 100 index dropped more than 2% to close at 4912.4, its lowest level for more than three years. In New York, the Dow Jones industrial average closed down 449 points at 10,609, 25% below its peak in October last year. The price of gold rose 11% in its biggest ever one-day gain as investors searched for havens.
Gordon Brown intervened to broker a solution to HBOS, and Downing Street made clear it was prepared to rip up competition laws to allow the takeover - a move which may cause the loss of tens of thousands of jobs and the closure of up to 500 branches. After intense negotiations, a deal was clinched shortly after 9.30pm, and is to be announced this morning. The two companies agreed that Lloyds TSB would pay 232p per HBOS share.
Earlier, in an extraordinary day of trading for HBOS, shares in the bank halved in the first hour and at one stage stood at 88p. This sell-off led to news coming out of the proposed takeover, part of a contingency plan by the government to prevent a repeat of the Northern Rock fiasco. HBOS shares leaped above their opening level briefly, before another sell-off and closing the day down 20%.
Other banks were also caught in the turmoil. Royal Bank of Scotland fell 10%.
By the close of business:
· Shares in Morgan Stanley and Goldman Sachs had been pummelled. The two remaining investment banks after the collapse of Lehman Brothers and the takeover of Merrill Lynch faced questions about their ability to withstand the global turmoil. Shares in Goldman Sachs were down 19%. Morgan Stanley had a 24% decline, causing its chief executive, John Mack, to attack "irresponsible" speculators for spreading fear and rumour.
· The Dow Jones industrial average fell almost 4%, leading the securities and exchange commission - the US financial watchdog - to announce a clampdown on short-selling of shares, a process whereby speculators borrow stock in order to sell it and then buy it back at a lower price.
· The Bank of England announced that it was extending its special liquidity scheme, which is intended to ease pressures on banks, until the end of January. Until this week's turmoil in the markets, Mervyn King, the Bank's governor, had insisted that the facility, introduced in the wake of the collapse of Bear Stearns in the spring, would be closed next month.
The announcement came as government figures showed a 32,500 rise in the number of people out of work and claiming benefit last month, the biggest increase for 16 years.
A terse statement to the stock exchange by HBOS at lunchtime confirmed that it was in merger talks with Lloyds TSB: "In the light of market speculation, the board of HBOS confirms it is in advanced talks with Lloyds TSB which may or may not lead to an offer being made for HBOS." Lloyds TSB made no comment on the proposed deal then, but it was understood that its chairman, Sir Victor Blank, and chief executive, Eric Daniels, would be at the helm of the newly merged company.
City sources said last night that the relatively small amount of cash withdrawals from HBOS - amounting to £1bn of its £250bn of deposits - showed that the bank was fundamentally sound but had fallen foul of a collective loss of investor confidence in the banking industry.
A link-up between the two high street banks would normally fall foul of Britain's tough competition laws, but the Treasury made clear that John Hutton, the business and enterprise secretary, would use emergency powers to stop it being referred to the Competition Commission. Government sources said the severity of the crisis meant there was no alternative but to waive competition rules.
HBOS, which owns Halifax, insisted on Tuesday it was not in trouble, but is seen by the markets as particularly vulnerable to the fall in UK house prices. The bank has 22 million customers, accounts for 20% of the mortgage market, and takes in one pound in every six saved in the UK.
The US authorities were last night scrutinising the health of Goldman Sachs and Morgan Stanley following a 10-day period in which they have nationalised the country's two biggest lenders - Fannie Mae and Freddie Mac - refused to bail out Lehman Brothers, helped orchestrate the takeover of Merrill Lynch, and provided an $85bn lifeline to AIG, whose failure would have sent shockwaves through the global financial system. The insurer said it would be business as usual, albeit under government control.
New York state's insurance superintendent, Eric Dinallo, who helped broker the bailout, accused firms of poor management in diversifying far too broadly.
"It is clear to me that financial services and insurance has gotten away from its core competence and that is dangerous," said Dinallo, who compared such companies' strategies to driving a car while putting on make-up, looking at a BlackBerry and having a conversation.