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The pressure continued on Tuesday as the focus shifted to the insurer AIG, which had lost a fortune guaranteeing US mortgage-related investments.

The fear spread throughout the market, engulfing even Goldman Sachs and Morgan Stanley. The two leading Wall Street investment banks had weathered the credit crunch pretty well, but their share prices tumbled amid claims that the days of the independent investment bank, which are so dependent on the confidence of clients and lenders, were numbered. John Mack, Morgan Stanley’s chief executive, decided that he might need to find a partner by the end of the week and started talks with Wachovia, a large and troubled US bank, and with China Investment Corp, the Chinese sovereign wealth fund that has a 9.9 per cent stake in the bank.

Top bankers gave warning that the failure of AIG would be much more damaging than that of Lehman Brothers. The Federal Reserve reached the same conclusion and on Tuesday night it agreed to take control of the company in return for an $85 billion loan.

Over in London, the management of HBOS, the country’s biggest mortgage lender, was in talks with Lloyds TSB about a rescue takeover. HBOS shares had fallen 18 per cent on Monday and at one stage on Tuesday were down a further 40 per cent.

The tumbling share price caused alarm in Downing Street. If the Government was forced to bail out another bank, after the debacle of Northern Rock last year, Gordon Brown’s struggle to survive would surely be over. On Monday night Mr Brown met the Lloyd TSB’s chairman, Sir Victor Blank, at a City dinner and told him the Government would waive through a takeover by Lloyds TSB, overruling any objections from the competition authorities.

On Wednesday morning Lloyds TSB announced that it was buying HBOS for £12 billion. The accusation that HBOS had been forced into the deal — which may result in the loss of tens of thousands of jobs — because of short-seller hedge funds driving down the share price provoked outrage and prompted demands for a ban on short-selling.

But the rescue of AIG and HBOS did little to calm markets on either side of the Atlantic. The FTSE 100 tumbled a further 2.25 per cent on Wednesday, for a fall of more than 9 per cent in just three days.

London share prices fell again on Thursday and with bank shares showing further declines the Financial Services Authority announced a temporary ban on short-selling. Soon after the FSA’s announcement, which came after the London market had closed, reports began to circulate that the US Government was planning a bailout of US banks. The impact was explosive. Share prices rocketed in New York, with the Dow Jones closing up nearly 4 per cent. When Asian markets opened the relief rally caught fire and by the time the London market closed, the FTSE 100 had soared 8.8 per cent, its biggest one-day rise.

The jump in the share prices of Britain’s biggest banks was breathtaking: Royal Bank of Scotland up 31 per cent, Barclays up 29 per cent, Lloyds TSB up 20 per cent.

The ban on short-selling helped. But the jumps also reflected hopes that the US Government’s proposal will bring relief to bank balance sheets and encourage institutions to start lending again. In other words, the end of the credit crunch.

By taking toxic US mortgage assets off bank balance sheets, Mr Paulson hopes to unblock the system that is “choking off the supply of credit”. British banks hold some of these US mortgage-related assets and should benefit from the rise in prices as the US Government starts buying them from US banks. The hope is that this will translate into renewed lending between banks and, ultimately, lower mortgage rates.

In contrast with the euphoria on the stock market, the initial impact on interbank lending rates yesterday was negligible. Bankers said conditions should start to ease fairly quickly, however.

The impact on some of the banks that have been under most pressure in recent days was dramatic. Morgan Stanley’s share price was up 25 per cent at one stage, prompting speculation that it might no longer need to find a partner, although it continued its negotiations.

Some bankers suggested that if the plan had been announced last Friday it would have dramatically changed events. It would have bought Lehman more time, might have allowed Merrill Lynch to remain independent and might even have avoided the need for a rescue of HBOS.

That will hardly bring cheer to the thousands of HBOS employees who are set to lose their jobs.

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