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The FTSE 100 closed down 3.29 per cent – rocked by the bankruptcy of investment bank Lehman Brothers, the sale of Merrill Lynch and fears about AIG.

The index recovered from earlier losses that saw it fall as much as five per cent, as in New York the Dow Jones opened with falls, but not as great as some feared.

The US index at 16:49 BST stood down 2.5 per cent to 11,135.88 – with traders buoyed by the fact at least Merrill Lynch could be saved.

In London, financial firms took the brunt of the losses, but commodity stocks also took a pounding.

Friends Provident was down 17.85 per cent, while HBOS dropped 17.46 per cent.

Miner Kazakhmys was down 11.87 per cent, Cairn Energy fell 11.47 per cent and ICAP slid 11.72.

Despite the widespread fall, some firms did make gains, in particular travel firms, as traders no doubt looked to make a getaway amid the trauma.

Thomas Cook was up 1.89 per cent, British Airways gained 1.55 per cent and cruise operator Carnival rose 0.87 per cent.

Capita Group and Centrica rose 2.35 per cent and 1.34 per cent respectively.

Ryan Kneale, Market Analyst at City bookmaker BetsForTraders.com, said: "We have one bankrupt investment bank, another saved by a last minute buyer and rumours that the world's largest insurer is in deeper trouble than they would have you believe.

"People have been saying for months that we are 'through the worst of it', however that statement seems laughable now as it's utterly chaotic out there today and who knows what the other banks are hiding. If you haven't put your tin hat on yet, then now is the time to do so, because the potential for carnage is huge!"