When elderly patients are admitted to hospital in the dead of night, they often need a cup of tea and a sandwich to restore their energy, as well as the more urgent medical attention. It's a simple thing, designed to make a stay in hospital a little more comfortable, a little less daunting.

But at Bradford Royal Infirmary, a hospital that prides itself on the personal care it gives to patients, the sandwiches are now deemed an unnecessary expense.

So too are the security guards who patrol its large car park. A female doctor was attacked last week as she went to her car. Hospital staff are now insisting that security be improved before any more of them are hurt.

The disappearance of the snack boxes and the security guards are the visible sign of the crisis at what was formerly one of Britain's leading hospitals. So, too, is the cutting of temporary nurses, caterers and some 200 other posts.

An Observer investigation has found that the situation faced at Bradford need never have happened had it been differently handled. It is a warning of what could lie ahead for other foundation trusts, the government's flagship NHS organisations whose independence was supposed to transform healthcare.

Those involved in the saga have spoken about their alarm at the way in which a New York firm was called in, at great cost, to try to sort out the situation, and the way in which ministers have tried to wash their hands of the affair. A number of consultants wrote a letter saying medical care was under threat, but the bigger question is what it means for the future of Tony Blair's health reforms. If a leading and respected hospital can't handle its status as a foundation trust, what can?

Bradford Royal Infirmary, an impressive 1920s stone building that overlooks the city, has a solid history of providing care for its citizens. It was built with public subscriptions, and the wealth that came from the textile industry helped the many thousands of workers who came to work in the mills.

Today, with a budget of more than £200 million, it serves a city in which 66 different languages are spoken, a city with high rates of poverty and heart disease, but also one where there is great loyalty towards the hospital. It is a picture replicated in many cities around the country.

The way in which the Bradford Royal's fortunes have turned around in the course of three months is little short of astonishing.

The Royal College of Nursing's regional representative, Sue West, said there is now a shortage of all kinds of goods as the cuts begin to bite, including clean linen and basic equipment such as tubing.

'It's very difficult for nurses, because of the pressure they are under. We're all worried about job cuts. You might think that getting rid of snack boxes so there's food available all the time is a sensible saving. But if you have a very ill patient who can hardly eat, then having a meal when you need it is hardly a luxury, is it?'

Nine months ago, it was a different story. On 1 April last year, the Royal Infirmary and St Luke's Hospital, both serving the city and part of the same Bradford Teaching Hos pitals NHS Trust, were celebrating having been given foundation status - one of the first 10 hospitals considered worthy of being picked out.

Although the term 'foundation trust' meant, and still means, little to the public, it had received enormous coverage within the NHS. Central to the concept was that the new independent organisations were to be freed from central government control. The idea came from the former health secretary Alan Milburn, now back in the Cabinet as Labour's election co-ordinator, as he was touring continental Europe in 2000, looking for new ways of reforming the health service. A set of Spanish hospitals, known as fundaciones , caught his attention.

Milburn wanted to provide NHS staff with incentives so that their hospitals would be financially rewarded for keeping their costs down and for treating more patients. He had grown tired of the fact that everyone was paid the same, whether they offered the best or worst services to patients. The crucial aspect was that they would be able to keep any extra money they made and plough it back into new wards or paying for a high-flying consultant.

Gordon Brown, the chancellor, had already decided to put billions into the NHS, representing a twofold increase on spending by 2008 on the figures they had inherited in 1997. The method of funding healthcare would stay the same, coming from central taxation, but the system of delivery would change.

Tony Blair had also become convinced that foundation hospitals could lead to new ways of thinking about healthcare by helping good managers to cut the waiting times and to develop more preventive care. In the end, patients, and the general population, would see improvements in treatment, after-care and advice. That was the theory.

From the outset, foundation hospitals were hugely controversial, because their development left some hospitals under government control, potentially leading to a two-tier system. But after a series of battles in Parliament, they were finally launched last April. For Bradford, it looked like a glorious moment.

Only the very best hospitals were given the chance to 'go foundation' and the future, for staff and for patients, looked rosy. Last February, the hospital predicted a £2 million surplus in the first year, and Monitor, the body regulating foundation trusts, had approved all their figures.

But then things started to go badly wrong. As the months rolled by, it became apparent that the finances were not so secure. First, the new consultants' contract, to cover revised working arrangements, cost the trust £2.9 million extra.

The real headache, however, proved to be the new system known as 'payment by results'.

Under this system, hospitals are rewarded for seeing more patients more quickly. In particular, a bonus payment of £1,200 is given to foundations that admit patients but then send them home within 48 hours.

Last year, Bradford had an 11 per cent increase in the number of the patients it saw. This meant a much bigger bill for the primary care trusts, the organisations, often groups of GPs, that commission hospital services and pay hospital bills. A dispute arose between the hospital and its local PCTs over exactly how much they should be paying.

David Jackson, the urbane and impressive chief executive who has spoken at length to The Observer , felt it was nothing that couldn't be sorted out with a few meetings. He went to London to talk to Bill Moyes, the head of Monitor, full of optimism that this was no more than a little local difficulty. Although it thought it was heading for a £4m loss, the trust has an overall budget of £220m, so it was well within its limits.

But Jackson was wrong. Moyes startled him when he said that they would be issuing a formal notice forcing them to depart from their original plans and sort out their finances.

'It came as a big shock. We knew things were going to be difficult - every year is difficult in the NHS - but we had no reason to believe we couldn't resolve it. I think the reputation of the NHS in Bradford was damaged by all the resulting publicity.'

Even within the Department of Health, there was unease over the move, which also included removing the chairman of the trust, against the wishes of its board of governors.

'It seemed such a macho and aggressive tactic, and we felt that Moyes was trying to make his mark, and win a scalp,' said one official. 'It just happened to be Bradford's scalp he took.'

This is a charge that Moyes, and Monitor, completely deny, insisting that they had to step in before matters got worse. Moyes decided to appoint a team of American recovery specialists, Alvarez and Marsal, to try to develop a new financial plan for the hospital.

Jackson pleaded with Moyes not to use the men from New York. 'He told them that it wouldn't go down too well in Bradford,' one hospital manager said. 'But Moyes was adamant that he wasn't going to use KPMG or any of the usual lot.'

When the New Yorkers arrived at Bradford Royal Infirmary, they were in for a surprise. Many of the staff did not understand their accents, and they, in turn, appeared to know very little about the NHS.

One consultant said: 'This guy had a piece of paper and kept asking me how many dollars it would cost to perform a particular operation. I told him: "We don't actually work in dollars here. It's pounds and pence, I'm afraid." It was completely farcical.' The report prepared by A&M cost the trust £160,000, a sum they could scarcely afford.

There was worse to come. John Ryan, a local councillor who was hugely admired for his work in improving the hospital, was moved as chairman. An interim chairman, Peter Garland, was installed and given just a few weeks to prepare a report over the Christmas holiday.

That recovery plan now has to be agreed by Moyes and put before staff. They are understandably nervous. Philip Bickford-Smith, an anaesthetist and chairman of the medical staff committee, said: 'As you might imagine, there is a great feeling of unease.

'We know that the wages bill has to be cut, and there will be a natural turnover of staff, but I think some very hard decisions have to be made.'

He believes that the hospital has already been hurt by the government's 'patient choices' agenda, which means that patients - and primary care trusts - can choose to go for routine surgery to a private clinic or another NHS hospital rather than Bradford.

'It's the routine day surgery that is profitable for us so, if we lose a lot of that to other centres, we are undermined,' he said. 'This is about market forces, over which we have little control.'

What upsets those at Bradford is that other hospitals around Yorkshire face much bigger deficits. The West Yorkshire Trust, which covers Wakefield, is heading for a £35m deficit this spring - but it has been bailed out by the Department of Health. Leeds is heading for debts of around £16m.

But foundation trusts cannot be given this help, because they are independent and stand or fall by themselves. The Health Secretary, John Reid, has made it clear to local MPs that he will not intervene, although he is taking a close interest in how the recovery plan works out.

For Jackson, a man who had turned the trust's fortunes around in just five years, he is not sure he can praise the virtues of foundation status in the way he once did. 'Ask me in a year's time what I think of foundation trusts,' he said. 'What has impressed me is the stoicism of the staff and the local people. There's a real work ethic here, and a feeling that we must get through this together.

'Why did we want foundation status? Because, ever since I've been in the health service, it has been run by this big central bureaucracy and here was a chance to do do things differently, to suit local interests so that local people might own it.'

Yet much of that local accountability was taken away from them when Monitor stepped in to intervene. The Labour MP and former health secretary, Frank Dobson, who has been a long-standing opponent of foundation hospitals, said: 'This hospital was meant to be one of the best in the country, the crème de la crème, and yet we're meant to believe that suddenly it fell into crisis.

'If this outside regulator brings in men from New York and sacks the chairman, how does that represent the idea that local people will own their hospital?'

West, the RCN representative, knows that the medical staff now feel under more pressure, worrying about resources and the ever present sense of financial crisis.

'I don't think anyone ever thought that being a foundation hospital would lead to this,' she said. 'But the truth is, it might get worse. All we can do is watch and wait.'