Global financial markets were shaken to their core on Monday after Lehman Brothers filed for bankruptcy protection and Merrill Lynch agreed to be taken over as a deepening crisis took new, bigger victims.
The U.S. Federal Reserve also said for the first time it will accept stocks in exchange for cash loans and 10 of the world's top banks agreed to establish a $70 billion emergency fund, with any one of them able to tap up to a third of that.
On a black Sunday for Wall Street, frantic attempts to find a rescuer for Lehman failed, and troubled insurer American International Group asked the Fed for a lifeline, according to news reports.
But Bank of America agreed to buy Merrill Lynch in an all-stock deal worth $50 billion, seeking a bargain as the world's largest retail brokerage sought refuge from fears it could be the next victim.
"It's a return to pure capitalism, the survival of the fittest — the government can't and won't bail everybody out," said Justin Urquhart Stewart, investment director at 7 Investment Management in London.
"Investors will now retreat to the trustworthy banks, though that's not a phrase that trips off the tongue easily nowadays."
Asian and European stock markets tumbled as the worries about Lehman counterparty risk and further financial market turmoil sent investors scurrying for safe havens such as gold.
The FTSEurofirst 300 index of leading European shares fell over 3 percent, led by falling bank stocks such as UBS, down over 7 percent.
Shares in U.S. banks trading in Frankfurt tumbled, with Lehman down 85 percent and Morgan Stanley, Citigroup and others all in retreat.
Merrill's shares offered a rare bright spot and its Frankfurt-based shares jumped 38 percent. Bank of America said it had agreed to buy Merrill in an all-share deal for the equivalent of $50 billion, or $29 a share, almost $12 a share above Friday's closing price.
Lehman said it filed for Chapter 11 protection and was attempting to sell assets, becoming Wall Street's highest-profile bankruptcy since junk bond specialist Drexel Burnham Lambert succumbed in 1990.
It followed three days of talks between bank CEOs and regulators at the Fed's fortress-like Manhattan building, showing Wall Street and Washington accepted decisions on priority and need were needed in the face of the credit crisis and U.S. housing bust.
"This shows the U.S. 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 a panic on the markets," said Marie-Pierre Pillon, head of equity and credit research at Groupama Asset Management in Paris.
S&P500 share futures were down 3 percent, signalling U.S. stocks will open sharply lower, and the dollar tumbled.
The euro jumped to as high as $1.4479, up 1.7 percent from Friday, while U.S. Treasury yields dropped to five-month lows on concern about the stability of the U.S. financial system and as investors increased bets the Fed will cut interest rates.
SHAKE-UP
The events signalled a transformation in Wall Street's power structure with major banking groups like Bank of America and JPMorgan Chase becoming more dominant.
With Lehman and Merrill out of the picture, three of the top five U.S. investment banks have effectively departed the scene inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.
Britain's Barclays emerged as a front-runner to buy Lehman late on Sunday after Bank of America pulled back, but it was deterred by the U.S. government's unwillingness to provide a financial backstop to potential losses.
Lehman collapsed under the weight of toxic assets, mainly related to real estate, that are now worth only a fraction of their original prices.
In its bankruptcy filing Lehman said Citigroup, Bank of New York Mellon, Japan's Aozora Bank and Mizuho Financial Group were among its top unsecured creditors.
LINE IN SAND
Lehman employees streaming into its European headquarters in London's Canary Wharf financial district were met by television cameras, a scrum of reporters and a beefed-up security team.
"I guess times are tough and we've got to face the music … Everyone is worried about their job, it's inevitable," said one banker entering the building, adding a company-wide meeting had been set for Monday morning.
Other employees said staff were clearing desks, packing personal belongings and saying farewells to colleagues.
The New York Times also reported that AIG, once the world's largest insurer, had made an approach to the Federal Reserve seeking $40 billion in short-term financing.
Late on Sunday, authorities sought to prop up market confidence with announcements from regulators including the Fed and the U.S. Securities and Exchange Commission.
The Fed said it would begin accepting equities as collateral for emergency loans, and laid out a series of steps to calm markets and brace for the collapse of Lehman.
In addition to broadening the collateral it will accept from investment banks for direct Fed loans, it said it would increase the amount of Treasury securities it auctions on a regular basis under one of its lending programs.
One of the catalysts for this weekend's events was the stance of U.S. Treasury Secretary Henry Paulson, who opposed using government money to resolve the Lehman crisis.
So far this year, the government has sponsored rescues of Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae, and the authorities did not want to be accused of encouraging excessive risk-taking by bailing out another yet another investment bank. But they also could not afford to let a blow-up of Lehman paralyze the financial system and deepen the credit crisis.
The SEC will take action against abusive short-selling, according to a source briefed on the matter. In late July and early August, major financial shares were protected by an emergency rule that expired on Aug. 12.
