As regular investors were frightened away from the market by Lehman Brothers’ bankruptcy and the rescue takeover of Merrill Lynch by Bank of America, it was left to the bearish hedge funds to hunt for the next victim(s) of the global financial crisis. In Britain, their gaze came to rest on HBOS and Friends Provident.

HBOS, the Halifax and Bank of Scotland owner, fell as much as 40 per cent at one stage, a whopping 102.4p, to 179.6p before recovering to close down 49½p at 232½p. HBOS is the British institution with the biggest exposure to mortgage-backed assets, the toxic instruments that proved fatal for Lehman.

Simon Pilkington, a Cazenove analyst, said that the forced sale of assets by Lehman’s liquidator would drive write-offs by other banks: “We expect additional valuation write-downs from all the UK banks and particularly Barclays, Royal Bank of Scotland and HBOS . . . We are particularly cautious on HBOS, given its exposures and funding structures.”

Royal Bank of Scotland slipped 29¼p to 210½p and Barclays fell 34½p to 316p. Alex Potter, a Collins Stewart analyst, said that, with banks unwilling to lend to each other after Lehman’s collapse, Barclays was more exposed than RBS because 13 per cent of its loan book was not covered by deposits and securitisations, compared with 7.7 per cent for RBS.

The FTSE 100 index, at one stage down 291 points, ended a gloomy day 190.70 points lower at 5,204.20.

A third calamity of Wall Street – the plea by AIG, the insurance giant, for a $40 billion (£22.4 billion) bailout from the US Federal Reserve – made Friends Provident the index’s worst performer, down 17.6p at 81p. A large part of Friends’ business is insuring people’s mortgage payments and it was AIG insuring mortgage assets that led to its massive losses.

Insurers have also bought unquantified billions of dollars of derivatives from Lehman Brothers to help them to guarantee customers’ pensions. This worry hit Prudential, down 51p at 500p, and Aviva, off 44p at 489½p. Only RSA Insurance, buoyed by talk of a bid from Allianz or Generali, was up, in its case a meagre 0.2p at 158.1p.

Lehman is a key client for Icap, the interdealer broker, so it fell 53½p to 435p. It is also the biggest trader on the London Stock Exchange, which lost 42p to 736p. The exchange’s Baikal plan for a pan-European trading platform – due to be launched early next year as a joint venture with Lehman – is likely to be put on ice, but an LSE spokesman said that talks to bring in other investment banks as investors would continue.

Thomson Reuters, the provider of now unwanted trading screens to Lehman’s traders, fell 119p to £14.

Mining stocks, such as Kazakhmys, down 121½p at 780p, crashed as metals prices fell amid fears that the financial crisis would weaken Chinese demand.

In the FTSE 250, Bradford & Bingley slid 5¾p to 31½p. Yell lost 16p to 95p and Trinity Mirror fell 9¾p to 104¼p after Gannett, of the United States, said that classified advertising at its British newspapers had fallen by 30 per cent in August.

New York: Lehman Brothers’ collapse took a brutal toll on Wall Street as investors flocked to safe havens, such as government bonds. The Dow Jones industrial average closed 504.50 points lower at 10,917.50.

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