Asian markets finished the week in near freefall on Friday, gripped by panic that the US sub-prime lending problem was on the brink of triggering a full-scale global financial crisis and the liquidation of several huge hedge funds.

Stocks plunged across all major Asian bourses from Taipei to Ho Chi Minh as equities became the front-line victims of a trading stampede of investors desperate to raise cash quickly amid tightening money markets. Hardest-hit was the Kospi index of Seoul-listed shares, which shed over 4 per cent of its value in one day.

In Tokyo, where the benchmark Nikkei 225 Index crashed more than 400 points, brokers said that the day’s trading patterns provided clear signs that at least one large, quality-orientated, hedge fund was in meltdown.

Investors also wrestled with the possibility that Japanese banks either do not know – or have dramatically misreported – their exposure to the US sub-prime crisis.

One of Japan’s “big four” megabanks, Mizuho, yesterday admitted to a ¥600 million loss arising from sub-prime related securities sales, but would not reveal the extent of its exposure now.

As one Tokyo-based broker put it: “In theory, the Japanese banks should not be exposed too heavily to US sub-prime as they have not been chasers of high-yield in recent years. But history tells us that at the end of every global financial crisis there is usually a Japanese bank caught with its pants down.”

Traders said that “insane” movements of particular shares – where two companies in the same sector respectively rose and fell 10 per cent in a single session – were evidence of so-called “pair trades” of simultaneous long and short positions being unwound in a hurry by statistical arbitrage funds.

“You can tell by the stocks involved that this fund was an investor in high-quality Japan Inc equity,” said one broker at Daiwa Securities. “There have been persistent rumours that the portfolio involved was something like a Goldman Sachs fund, but the trading pattern seems simply too brutish and breathless for a company with that sort of market savvy.”

Whichever the fund was, brokers said that it massively exacerbated the overall slide as investors rushed to second-guess which would be the next blue-chip stocks to experience unnatural selling-pressure. Every Japanese stock whose shareholder register had Goldman Sachs Asset Management on it, said one broker at CLSA, was heavily sold.

One Nomura trader said that the extreme volatility of the pairs trades unwinding made forced sellers of many highly-leveraged market-neutral funds. “Those funds, which are committed to remain within 0.5 per cent of a particular index, now find their holdings lurching between 3 and 5 per cent from the index and the result is chaos,” he said.

The wider problem, he added, is that Japanese stocks have been under extremely close analytical scrutiny and many funds, while believing themselves to be using unique risk versus valuation models, have in fact all selected the same pairs trades. The unwinding of those is accordingly more violent.

The “nightmare scenario” for Asian investors, said the manager of one large hedge fund, is that a market slide goes from orderly to uncontrollable – a situation which many believe could arise if central banks are unable to pump enough liquidity to offset the credit crunch. “At that point, it gets nasty and control of the fund shifts from the trading manager to the risk manager and the unwinding begins. The most natural place to start raising cash in illiquid money markets is in those lovely liquid equity markets and that is what we are starting to see.”

Following similar efforts by the European Central Bank and US Federal Reserve, the Bank of Japan supplied ¥1 trillion (£4.1 billion) to the money market in an effort to pour liquidity into the growing dysfunction of money markets.

In what was seen by analysts at Mitsubishi UFJ Securities as a clear signal of worse turmoil to come, the Japanese central bank injected an additional ¥600 billion of forward liquidity in an attempt to keep the money markets operating normally for the next week – a holiday period where most Japanese companies stop work.

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