The US financial system faces an unprecedented shake-up with Lehman Brothers filing for bankruptcy, Bank of America buying Merrill Lynch, and the Federal Reserve saying for the first time it will accept shares in exchange for cash loans.
On a black Sunday for Wall Street, ten of the world's biggest banks also agreed to establish a $70 billion emergency fund, with any one of them able to tap up to a third of that.
And separately, troubled insurer American International Group asked the Fed for a lifeline, according to news reports.
The events, which followed three days of talks between bank CEOs and regulators at the Fed's fortress-like Manhattan building, indicate that Wall Street and Washington were accepting that massive action is needed in the face of the credit crisis and US housing bust.
Lehman has become Wall Street's most high profile bankruptcy since junk bond specialist Drexel Burnham Lambert succumbed in 1990.
More on the fall-out from the Lehman collapse
The weekend events signalled a transformation in Wall Street's power structure with major banking groups like Bank of America Corp, which is buying Merrill Lynch, and JPMorgan Chase & Co becoming more dominant.
With Lehman and Merrill out of the picture, three of the top five US investment banks have effectively departed the scene inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.
The focus early on Sunday was on whether talks between regulators and Wall Street's top bankers would lead to the sale of Lehman, until recently the No 4 US investment bank.
Barclays' move triggers emergency trading session
Those talks faltered when Britain's Barclays, which had appeared to be front-runner to take over Lehman - excluding its toxic mortgage-related assets - said it had pulled out of the bidding.
That triggered expectations the investment bank was heading into bankruptcy and prompted a rare emergency trading session to allow Wall Street dealers in the $455 trillion derivatives market to reduce their exposure to the firm.
Then early this morning, 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 above Friday's closing price.
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.
Meanwhile, an emergency trading session was set between dealers with Lehman Brothers counterparty risk involved credit, equity, rates, foreign exchange and commodity derivatives, the International Swaps and Derivatives Association said.
Market sources said the special session was initiated by the Federal Reserve, with the aim of reducing risk associated with a potential bankruptcy filing by Lehman Brothers.
Lehman collapsed under the weight of toxic assets, mainly related to property, that are now worth only a fraction of their original prices.
One of the catalysts for this weekend's events was the stance of US Treasury Secretary Henry Paulson, who was strongly opposed to using government money in any deal aimed at resolving the Lehman crisis.
The lack of such government guarantees was the main reason Barclays decided to exit the negotiations to buy Lehman, according to a person familiar with the matter.
So far this year, the government has sponsored rescues of Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae. 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.
Bankruptcy ends 158 years of trade
The bankruptcy marks an ignominious end to a once-proud firm, founded by cotton-trading German immigrants 158 years ago. It also badly tarnishes the reputation of CEO Dick Fuld, who had insisted that his firm could work through its problems to survive as an independent entity.
Former Federal Reserve Chairman Alan Greenspan said yesterday he suspected 'we will see other major financial firms fail', but added that this did not need to be a problem.
'It depends on how it is handled and how the liquidations take place,' Greenspan said. 'And indeed we shouldn't try to protect every single institution. The ordinary course of financial change has winners and losers,' he added.
Hundreds of Lehman employees went into the office yesterday to clear desks and pack personal belongings, according to an employee. The news was a huge hit to an already wounded financial jobs market, and a dent to New York's claim to be the pre-eminent world financial centre.
