On Monday it insisted that swirling rumours of a lack of cash (liquidity problems) were malicious mischief making. On Friday a bank that for more than 80 years has been one of Wall Street’s blue-blooded names, was in deep trouble. Having admitted that it had a $2 billion exposure to mortgage securities, it further admitted it didn’t have enough money to pay its bills. That deterioration didn’t just happen in the space of 5 days and that encapsulates the problem that the banking community both here and in the US is facing.

In June 2007 the firm announced that two of its hedge funds were in trouble after investing heavily in sub-prime mortgages, it had to pump in $1.6 billion to prop them up. A month later the firm announced that the game was up and the funds had effectively lost all their value. But that wasn’t the whole story and Bear Stearns exposure was far larger than $1.6bn but they weren’t admitting it.

Banks simply don’t believe each other any more and consequently are not prepared to lend money to each other. Lenders on both sides of the Atlantic face their deepest problems for two decades as they struggle to come to terms with the losses associated with the sub-prime mortgage crisis.

In a dramatic move the Federal Reserve working through the auspices of J.P. Morgan stepped in with emergency funds to keep the beleaguered bank afloat for a further 28 days using a legal provision brought in during the great depression of 1928. Because it is not a bank that takes the public's deposits it wasn't entitled to the rescue package but J.P. Morgan is so the money was passported to Bear Stearns via J.P. Morgan.

Bear Stearns simply lost the confidence of every other bank in the USA and, despite the fact that the Federal Reserve had offered to trade wonky mortgage assets for Treasury backed bonds in just a couple of weeks after the Easter break, bankers and institutional investors in Bear Stearns (it is an investment bank and consequently does not have any private depositors like Northern Rock in the UK) wouldn’t even wait that long and withdrew money relentlessly until is simply ran out of cash.

The UK will not be inured to the contagion because just like America, UK banks are still sifting through their exposure to bad debt provision caused by the sub-prime lending crisis. Complicated financial instruments that bundled up good debt with bad and were then sold on and sold on again by financial institutions make it difficult for banks to assess their exposure.

In addition banks are also reluctant to admit to their exposure in an atmosphere where the slightest sniff of bad news can lead to a Northern Rock or a Bear Stearns.

The Bear Stearns fiasco will make lending criteria in the UK more stringent as banks take fewer risks and this will not be restricted to just mortgage lending. The criteria for personal loans, credit card debt, overdrafts and businesses loans will all become more stringent adding to the economic slowdown.

Tough times ahead just got tougher.