FBI agents arrested two former Bear Stearns hedge fund managers at their homes yesterday, the first Wall Street executives to be formally charged by the US Government in relation to the credit crunch.

Within hours of arresting Ralph Cioffi and Matthew Tannin, the Justice Department announced that it had charged more than 400 people, including 50 in the previous two days, in a three-month sting operation relating to cases of mortgage fraud that have collectively cost the victims an estimated $1 billion (£507 million).

Mr Cioffi and Mr Tannin were led in handcuffs from their homes respectively in Tenafly, New Jersey, and Manhattan, processed in the FBI's New York office and taken across the East River to a Brooklyn federal court.

Each faces nine counts of conspiracy, securities fraud and wire fraud for allegedly misleading investors over the true health of two Bear Stearns hedge funds they managed. The funds collapsed last summer under the weight of loss-making sub-prime mortgage investments, losing about $1.6 billion of their investors' money.

Both developments are part of a broader federal government investigation as the authorities respond to sustained public pressure for convictions. The Bear Stearns charges represent the first big case against Wall Street, while the other arrests concern those players in the housing industry, such as mortgage lenders and estate agents, who have exploited the housing bubble.

Prosecutors allege that the two Bear Stearns executives believed that the funds were in a grave condition and at risk of collapse as early as March last year but failed to communicate that to investors, according to the indictment.

“Rather than disclosing the true state of the fund to investors and lenders, thus allowing an orderly wind-down of funds, Cioffi and Tannin agreed to make misrepresentations in the ultimately futile hope that the funds' bleak prospects would change and that their incomes and reputations would remain intact.”

Much of the prosecution's case is thought to rest on an e-mail exchange between Mr Cioffi and Mr Tannin.

Robert Mintz, a former federal government prosecutor, said: “This is a very significant test case. The charges show that the US Government is determined to prosecute Wall Street wrongdoers. But sub-prime mortgages are so complicated and Wall Street's behaviour may be found to have been so systemic that it could be difficult to secure a conviction.”

Mr Tannin and Mr Cioffi deny the charges and have been granted bail. Susan Brune, a lawyer for Mr Tannin, said: “He is being made a scapegoat for a widespread credit crisis. He looks forward to his acquittal.” Lawyers said that, if convicted, the two could face jail sentences of seven to ten years.

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