Lehman Brothers' collapse into bankruptcy this morning was hailed as good news for free markets but disastrous for bank shareholders and financial markets.

The destruction of what was until recently Wall Street's fourth-biggest investment bank came as a result of the US government's refusal to put any more public money at risk to help bail out private companies.

The Federal Reserve had attempted to coral other firms, including Barclays, into launching a lifeboat to rescue the firm. But without the incentive of government guarantees like those given to JP Morgan in its takeover of Bear Stearns, nobody had the appetite.

Barclays issued a statement today saying: “We confirm that Barclays considered a combination with Lehman Brothers and decided not to proceed because it was not possible to conclude a transation in the best interests of Barclays shareholders.”

Lehman had been one of the most aggressive players in the market trading in securities backed by subprime mortgages. It was those vast liabilities that led to its problems and frightened off potential saviours.

Free marketeers declared it had to die, mainly because they are private companies but also because without the risk of bankruptcy, banks will continue to take foolish risks.

Allowing the bank to collapse will also stop traders making speculative attacks on the stricken bank.

However, that will not prevent the sense of terror among banks' shareholders that, all of a sudden, they now face the potential of major financial institutions being allowed to fold.

Marie-Peillon, head of equity and credit research at Groupama Asset Management, said: “This shows the US government is saying enough' after saving other institutions and that they see Lehman as a private affair. I think today and tomorrow there will be panic on the markets.”

Meanwhile, banks who had been counterparties to Lehman trades, or were holding debt and equity in the collapsed bank, were today attempting to work out their exposure.

Axa said that it was exposed to about €300 million (£238 million) of Lehman debt while the German financial regulator Bafin declared its banks' exposure “managable”.

It is far from clear what investors will get from the remains of Lehman. Under Chapter 11 the company is protected from its creditors while it attempts to run down its operations in a fairly orderly way.

Lehman said all of its broker-dealers would continue to operate and said customers could continue to trade or take other actions with respect to their accounts.

The bank is in talks over a sale of its asset management business, Neuberger Berman, and today said it was attempting a sale of its broker-dealer business. Neuberger is not part of the Chapter 11 filing and its portfolio management, research and operating functions remain intact, the bank said.

The US dollar plunged and safe-haven US Treasuries and gold prices jumped as investors fretted yet again about the state of the global financial market.

The Bank of England said it was monitoring conditions in the money markets and would act to stabilise them if necessary. As the morning went on, speculation began to spread that the Fed may decide on an emergency interest rate cut to stabilise the markets.

Lehman said in today's bankruptcy court filing that as at 31 May it had total debts of $613 million and assets of $639 billion.