After appearing earlier to have reached a deal, the seven-hour White House meeting, which was described by Mr McCain’s campaign as “a contentious shouting match”, broke up after a late rebellion by Republican right-wingers against the plan’s huge price-tag.
Leading Democrats, including House Speaker Nancy Pelosi, reacted so angrily to the last-minute change in Republican demands that Henry Paulson, the Treasury Secretary, got down on one knee to beg them not to disclose how badly the meeting had gone, witnesses said.
Mr McCain, the Republican presidential candidate, was personally blamed by Harry Reid, the Democratic Senate Majority Leader. “John McCain did nothing to help – he only hurt the process,” Sen Reid said.
Stock markets tumbled across Asia early on Friday after the failure of the summit, having risen on earlier hopes of success.
The dramatic developments came as Washington Mutual, America’s largest savings and loan bank, collapsed in the biggest banking failure in the country’s history. Control of the bank was seized by the Government, which sold most of it to JP Morgan, the New York banking giant.
The failure to reach an agreement over the bailout plan may also throw the Presidential campaign into chaos, potentially delaying the first of the debates between Mr McCain and Mr Obama – scheduled for Friday evening.
Bitter political divisions emerged in the summit. Richard Shelby, a conservative Republican senator, said that Mr Bush’s plan was “flawed from the beginning”.
Barney Frank, a Democrat Congressman and the Financial Services Chairman, reacted angrily, saying Republicans had waited until the last moment to reject the plan and present an alternative proposal.
Mr Bush’s deal would see American taxpayers buy potentially ruinous “toxic” debts run up by banks. It is hoped this will keep them from collapsing, which could set off a cascade of ruinous events including wiped-out pensions, home repossessions and mass lay-offs. It must be approved by Congress in a final vote.
The Washington Post reported that before the meeting broke up President Bush warned of the repercussions if the deal did not pass. “If money isn’t loosened up, this sucker could go down,” he said, according to one person in the room.
Towards the end of the White House summit, some Republicans circulated an alternative scheme, which would see less focus on the Government buying up toxic assets and more on it merely providing insurance.
Mr Bush gave warning this week that his administration’s plan represented the best chance of the US avoiding a severe recession or even a depression.
In a television address on Wednesday he said that America’s “entire economy is in danger” and that, without the bail-out, markets “could slip into a financial panic and a distressing scenario would unfold”.
Raising the spectre of the 1930s, he said that “major sectors of America’s financial system are at risk of shutting down”. He added that America would face a “long and painful recession” unless Congress acted “immediately”.
He told the White House summit: “All of us around the table … know we’ve got to get something done as quickly as possible”.
As the earlier negotiations appeared to be going smoothly, Senator Chris Dodd, the Democratic chairman of the Senate banking committee, said “fundamental agreement” had been reached on a set of principles for the Bill to be passed within the “next few days”.
The Bush administration had already agreed to demands from the right and left, including that executives of failed companies must not be given big bonuses.
When, as seems likely, a deal is eventually reached, Gordon Brown could come under pressure to introduce a similar scheme for Britain’s struggling banks.
The Prime Minister is travelling to Washington to meet President Bush and discuss the global financial crisis.
The bail-out package would allow the US government to buy stricken housing-related investments from banks, but will dramatically increase the size of the budget deficit and leave taxpayers with a significant bill.
British banks with operations in the US, such as Barclays and RBS, have been encouraged to use the scheme.
A number of Congressmen had expressed doubts about the original form of the plan and those concerns sent the cost of borrowing higher.
The bail-out plan follows the most turbulent month in Wall Street since the 1930s.
Some of the world’s biggest investment banks have closed their doors, with Lehman Brothers collapsing, Merrill Lynch being bought in a surprise deal by Bank of America and the insurance company AIG effectively nationalised after being brought to its knees by poor investments.
The crisis was originally caused by a slump in the US housing market, with millions of so-called sub-prime borrowers defaulting against home loans.
However, with the entire financial system shaken, experts had warned that without a bail-out the American economy could have faced a second great depression.
Mr Bush and Hank Paulson, the Treasury Secretary, are hoping that their radical scheme – described by some commentators as a wholesale nationalisation of the American financial system – will ensure that the worst of the financial crisis is now over.
However, some suspect that, despite its generous scale, the scheme may not be enough to prevent a major recession in the world’s biggest economy.
An earlier bipartisan agreement on key principles for the plan gave the Bush administration just a fraction of the money it wanted up front.
It subjected half the $700 billion total to a congressional veto. The treasury secretary would have received $250 billion immediately and could have an additional $100 billion if he certified it was needed.