Two Bear Stearns hedge funds filed for bankruptcy protection, while investors in a third fund managed by the Wall Street bank were barred from withdrawing their money amid concerns that the credit crisis is spreading to other parts of the economy.

The bankruptcy filings headlined a raft of horrendous news for the $1.5 trillion (£740bn) global hedge fund industry and fanned fears of a profound global market correction that could reverberate into sectors far beyond America's sub-prime mortgage market, where the problems began. For the second time in a week, the FTSE 100 index suffered a major one-day fall, shedding 110 points, or 1.7 per cent of its value. Last week, the benchmark index had its biggest one-day drop in four years.

Yesterday's rout was set off by fresh concerns about the US credit market. Sowood Capital Management, which manages some of Harvard University's endowment, informed investors that it had lost about half of the $3bn that they had invested with the firm due to wrong bets on risky loans in America. Macquarie Bank, the Australian investment bank, told investors in two of its hedge funds that they were likely to lose a quarter of their cash. Shares in Man Group were hammered after it revealed poor weekly performance, too.

More pain is on the horizon, fund managers said. That is because most investment funds provide a monthly performance update to major investors. Industry insiders expect the numbers for July to be particularly poor. Jeff Meyer, chief executive of Gartmore, a London firm that manages more than £25bn, said: "The June marks were okay, the July marks are going to be worse. So in the first two weeks of August... you're going to see more of this stuff then. You're going to see more underperformance."

Those reports could lead to billions of outflows from the industry as investors seek safe havens. The hedge fund industry has achieved explosive growth in recent years on the promise of "absolute returns" - the idea that they will produce returns regardless of what happens in the larger market. Funds managed by the industry have tripled in the past six years. The quest for absolute returns sometimes means taking aggressive positions that leave them exposed when sudden shifts occur.

What began as a spike in losses for banks who granted mortgages to risky borrowers in the US caused the institutions that buy these loans in large packages to drastically re-evaluate how much they were worth. That crisis of confidence has percolated through the market, with investment banks becoming less willing to provide large debt packages that have funded the buyout boom of recent years. That has in turn deflated share prices that were propped up by bid expectations.

The upshot could be an end to the four-year bull market. Larry Jones, chief investment officer of NED Group, a fund of funds, said: "If the credit cycle unwinds, you are going to see a flight away from risky assets, and that includes equities, so investors could end up giving back some of the very nice profits they've made over the last four years. This is the end of the easy money."

The Chapter 15 Bankruptcy filings by Bear Stearns Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leverage were not unexpected.

Despite the panic selling, some remain confident that the underlying fundamentals for the economy remain strong. A fund manager said: "The system is clogged up. Some banks will be stuck holding debt for longer than they would like, but it will be cleared up in a couple months."

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