Edward Liddy, AIG's newly appointed head, was said to be poised to hold a huge sale of the company's assets in order to pay off a $85bn loan from the US Federal Reserve which helped save its business.

AIG, which has businesses ranging from life insurance to airplane leasing in 130 countries, is currently paying more than 11.4 per cent interest on the loan.

John Terrett, Al Jazeera's correspondent in New York, said: "The fall is not what we were expecting when we went to bed last night after hearing AIG had effectively been saved by the federal authorities.

"But banks are still not convinced that whoever they lend money to will still be in business tomorrow to pay them back... and until that cloud lifts over the financial system we are going to see the kind of gloom and worry that we are now being seen reflected in the Dow Jones Industrial Average.

"Markets... fear Morgan Stanley could be the next one to get into trouble."

Takeover talk

In London, shares in HBOS experienced wild swings during morning trading, climbing as high as $3.94 and falling as low as $1.58.

The bank's talks on being taken over by Lloyds TSB underscored how quickly authorities around the world are ditching long-held beliefs about free markets and competition as they seek to counter the credit crunch.

Lloyds TSB had only recently been blocked from buying a smaller mortgage bank due to competition rules.

Barclays, another British bank, had given Wall Street a small boost on Tuesday by agreeing to buy the investment arm of Lehman Brothers, the US bank which went bankrupt on Monday, for $1.75bn and taking aboard its 10,000 staff.

Barclays stock rose 10 per cent on Wednesday but major European stock indices turned lower after Wall Street's slide at the open.

In Ireland, the Bank of Ireland became the latest bank to cut its dividend, causing a sell-off in Irish banking shares.

Sensitive timing

The move to rescue AIG comes at a sensitive time given job losses and tax rates are key issues in the battle for the White House between senators John McCain and Barack Obama.

"In current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance," the US Federal Reserve said in a statement on Tuesday.

AIG had faced a cash crunch after $18bn of losses over three quarters, largely because of complex securities that are tied to mortgages, and which plunged in value as the nation's housing crisis deepened.

Investors and credit rating agencies had grown more doubtful that AIG could offset its losses with enough capital, which became prohibitively costly to raise as its share price plunged.

The Fed stepped in amid worries that a collapse of AIG could cause far-reaching damage to the global financial system.

Reacting to the news, Daniel Fuss, a bond manager who oversees more than $100bn at Loomis, Sayles & Co in Boston, said: "Thank God. AIG is interwoven with so many people and touches many companies around the world. This is a huge relief to many parts of the financial markets."