Image:Traders work on the floor of the New York Stock Exchange
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News of Merrill Lynch selling itself to Bank of America and Lehman Brothers Holdings filing for bankruptcy stunned traders on the floor of the New York Stock Exchange.
msnbc.com news services
updated 9/15/2008 5:54:12 AM ET 2008-09-15T09:54:12

In a stunning reshaping of America's financial landscape, two venerable Wall Street firms fell from the shock waves of a credit crisis that has plunged the financial system into turmoil, as stocks tumbled across the globe Monday in response.

Lehman Brothers, a 158-year-old investment bank choked by the credit crisis and falling real estate values, filed for Chapter 11 protection in the biggest bankruptcy filing ever and said it was trying to sell off key business units. Bank of America Corp. said it is snapping up Merrill Lynch & Co. Inc. in a $50 billion all-stock transaction.

Stock markets fell precipitously and Treasury bond prices soared as investors reacted to some of the most dramatic economic news in modern U.S. history. The Dow Jones industrial average closed down 500 points in their worst point drop since the September 2001 terrorist attacks.

The developments took place as U.S. voters, who rank the economy as their top concern, prepare to elect a new president in seven weeks. Presidential candidates John McCain, a Republican, and Democrat Barack Obama, immediately called for stricter financial regulation.

Obama called the news "the most serious financial crisis since the Great Depression" of the 1930s.

President George W. Bush meanwhile signaled that the government would not continue to bail out Wall Street, saying only that "we are working to reduce disruptions and minimize the impact of these financial market developments on the broader economy."

"The policymakers will focus on the health of the financial system as a whole," Bush said during the White House appearance with visiting Ghanian President John Kufuor.

The demise of the independent Wall Street institutions comes six months after the collapse of Bear Stearns and 14 months after the beginning of the credit crisis, sparked by bad mortgage finance and real estate investments.

Ominously, American International Group Inc., the world's largest insurance company, was asking the Federal Reserve for emergency funding and planned to announce a major restructuring Monday.

Consortium offers pool of funds
A global consortium of banks, working with government officials in New York, announced a $70 billion pool of funds to lend to troubled financial companies. The aim of the bank consortium, according to participants who spoke to The Associated Press, was to prevent a worldwide panic on stock and other financial exchanges.

Ten banks — Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley and UBS — each agreed to provide $7 billion "to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets."

The Federal Reserve also chipped in with more largesse in its emergency lending program for investment banks. The central bank announced late Sunday that it was broadening the types of collateral that financial institutions can use to obtain loans from the Fed.

Europe's major central banks also moved quickly to calm markets, pumping billions of euros and pounds into the financial system to shore up confidence.

The European Central Bank said it received 51 bids for $127 billion, or 90.3 billion euros, on its one-day tender of $42.6 billion, or 30 billion euros, with a bid rate of 4.25 percent, a clear sign that demand for cash is over the top.

Similarly, the Bank of England in London offered nearly $9 billion, or 5 billion pounds, in a three-day auction that drew bids for $43 billion, or 24.1 billion pounds, or nearly five times the amount that was offered.

The Zurich-based Swiss National Bank said it was also providing liquidity in "a generous and flexible manner" at an overnight rate of 1.9 percent, but wouldn't say how much was on offer.

Global markets take hit
Still, the FTSE-100 share index was down 4.07 percent in London, the Paris CAC-40 was off 4.5 percent and Germany's DAX 30 index of blue chips sagged 3.23 percent. India's Sensex tumbled 3.4 percent, Taiwan's benchmark index plummeted 4.1 percent and Singapore dropped 3.2 percent.

Lehman fell under the weight of $60 billion in soured real estate holdings, and the credit market's dislocation ultimately forced it to seek court protection. The credit crisis has caused global banks to write down more than $300 billion in asset value since last year, and caused the shotgun sales of Merrill Lynch & Co. and Bear Stearns Cos.

Lehman's bankruptcy filing marks the end of a Wall Street firm that started the U.S. cotton trade before the Civil War and financed the railroads that built a nation.

The company's roots began in 1844 when Henry Lehman immigrated from Rimpar, Germany to Alabama, where he established a dry goods store that catered to local cotton farmers in Montgomery. Lehman Brothers evolved from merchandising to a commodities broker, and then later into underwriting where the firm helped finance construction of the Pennsylvania Railroad, among others.

Chairman and Chief Executive Richard S. Fuld, who joined Lehman as a college student in 1969 and was the longest serving CEO on Wall Street, now has the dubious task of winding down the company's $639 billion of assets. It has about 25,000 employees worldwide, joining the swell of unemployed bankers and traders hurt by the credit crisis.

Many Lehman employees seen entering its headquarters in midtown Manhattan tucked their chins down to avoid talking to the media and others who had lined up behind metal barriers in front of the building.

Lehman's filing is the biggest corporate bankruptcy in history in terms of assets held, Mike Bickford of Jupiter eSources said. The next biggest bankruptcy was Worldcom Inc., with $126 billion in assets, and Enron Corp., with $81 billion. The figures are not adjusted for inflation.

In London, the administrators who have taken control of key Lehman Brothers' businesses in the United Kingdom said it could take years to dispose of the company's assets to pay off creditors.

Tony Lomas of PriceWaterHouseCoopers said liquidating those assets will be more complex than disposing of Enron's European assets, which took six years after the U.S. energy company's 2001 bankruptcy.

Lehman Brothers' filing came after all potential buyers walked away. They were spooked by the U.S. Treasury's refusal to provide any takeover aid, as it had done six months ago when Bear Stearns faltered and earlier this month when it seized mortgage giants Fannie Mae and Freddie Mac.

Raw emotions
Employees emerging from Lehman's headquarters near the heart of Times Square Sunday night carried boxes, tote bags and duffel bags, rolling suitcases, framed artwork and spare umbrellas. Many were emblazoned with the Lehman Brothers name.

TV trucks lined Seventh Avenue opposite the building, while barricades at the building's main entrance attempted to keep workers and onlookers from gumming up the steady flow of pedestrians flowing in and out of Times Square.

Some workers had moist eyes while a few others wept and shared hugs. Most who left the building quietly declined interviews.

People snapped pictures with cameras and their phones. Observers pressed up against a police barricade drew the ire of one man who emerged from the building and shouted: "Are you enjoying watching this? You think this is funny?"

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.

BofA and Merrill — a good fit?
Merrill Lynch, another investment bank laid low by the crisis that was triggered by rising mortgage defaults and plunging home values in the U.S., agreed to be acquired by Bank of America for 0.8595 shares of Bank of America common stock for each Merrill Lynch common share.

That values Merrill at $29 a share, a 70 percent premium over the brokerage's Friday closing price of $17.05, but well below what Merrill was worth at its peak in early 2007, when its shares traded above $98.

Bank of America has the most deposits of any U.S. bank, while Merrill Lynch is the world's largest brokerage. A combination of the two would create a global financial giant to rival Citigroup Inc., the biggest U.S. bank in terms of assets.

If the deal goes according to plan, Bank of America will be able to offer Merrill's retail brokerage services to its huge customer base. Where there is duplication, however, the combination of the two companies could result in more layoffs. Both Merrill and Bank of America have already cut thousands of investment banking jobs over the past year.

The deal would not come without risks, however. Merrill Lynch, like many of its Wall Street peers, has been struggling with tight credit markets and billions of dollars in assets tied to mortgages that have plunged in value. Merrill has reported four straight quarterly losses.

Bank of America's own finances are far from robust. As consumer credit deteriorates, the bank has seen its profits decline, and the company is still in the midst of absorbing the embattled mortgage lender Countrywide Financial, which it acquired in January.

Insurer AIG, hit hard by deterioration in the credit markets, said it is reviewing its operations and discussing possible options with outside parties to improve its business after a week when its stock dropped 45 percent amid concerns about the company's financial underpinnings.

The Wall Street Journal and The New York Times both reported early Monday on their Web sites that the American International Group is seeking an additional $40 billion in emergency funds — possibly from the Federal Reserve — to help it avoid a credit rating downgrade, which would make it more expensive for AIG to raise money. The insurer has already raised $20 billion in fresh capital this year.

‘One step away from a financial meltdown’
AIG was working with New York Insurance Superintendent Eric Dinallo and a representative of the governor's office through the weekend to craft a solution that protects policyholders, according to Dinallo's spokesman David Neustadt.

"It's clear we're one step away from a financial meltdown," said Nouriel Roubini, chairman of the consulting firm RGE Monitor.

The end of Lehman may not stop the financial crisis that has gripped Wall Street for months, analysts said. More investment banks could disappear soon.

The independent broker-dealers "are going the way of the dodo bird," said Bert Ely, an Alexandria, Virginia-based banking consultant.

That's partly because some of the firms, particularly Merrill, made bad bets on real estate. But several analysts said that investment companies will need the deep pockets of commercial banks to survive the next few years.

Roubini said it's difficult to accurately gauge the health of companies like Merrill because their financial health depends on how they value complex securities. As a result, their finances aren't very transparent, he said.

That can lead to a loss of confidence in the financial markets, he said, which can overwhelm an investment bank even if it is financially healthy by some measures.

"Once you lose confidence, the fundamentals matter less," he said.

The common denominator of the financial crisis, analysts said, is the bursting of the housing bubble. Home prices have dropped on average 25 percent so far. Roubini predicted they could drop another 15 percent.

The crisis has begun to slow the broader economy as banks make fewer loans and consumers have begun cutting spending. Many economists are now forecasting that the economy could slip into recession by the end of this year and early next year.

That, in turn, could cause additional losses for commercial banks on credit cards, auto loans and student loans.

The wreckage could prompt the Federal Reserve to do an about face and once again cut a key interest rate this week or possibly later this year. Just a few days ago, a rate cut appeared largely off the table, but now it has emerged as a possibility as the Fed prepares to meet Tuesday.

The International Monetary Fund predicted earlier this year that total losses from the credit crisis could reach almost $1 trillion. So far, banks have only taken about $350 billion in losses.

Crisis not over yet
For all their efforts, Lehman filed for bankruptcy.

The end of Lehman may not stop the financial crisis that has gripped Wall Street for months, analysts said. More investment banks could disappear soon.

The independent broker-dealers "are going the way of the dodo bird," said Bert Ely, an Alexandria, Va.,-based banking consultant.

That's partly because some of the firms, particularly Merrill, made bad bets on real estate. But several analysts said that investment companies will need the deep pockets of commercial banks to survive the next few years.

On Sunday, there was also an emergency trading session being held at the International Swaps and Derivatives Association to "reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy." The ISDA, which arranges trades for derivatives, said it was allowing customers to make trades and unwind positions linked to Lehman.

Roubini said it's difficult to accurately gauge the health of companies like Merrill because their financial health depends on how they value complex securities. As a result, their finances aren't very transparent, he said.

That can lead to a loss of confidence in the financial markets, he said, which can overwhelm an investment bank even if it is financially healthy by some measures.

The common denominator of the financial crisis, analysts said, is the bursting of the housing bubble. Home prices have dropped on average 25 percent so far. Roubini predicted they could drop another 15 percent.

The crisis has begun to slow the broader economy as banks make fewer loans and consumers have begun cutting spending. Many economists are now forecasting that the economy could slip into recession by the end of this year and early next year.

That, in turn, could cause additional losses for commercial banks on credit cards, auto loans and student loans.

Fed expected to cut rates
The Fed is widely expected to keep interest rates steady at 2 percent, below inflation, when it meets Tuesday. It was possible, however, that the central bank might decide in coming weeks to cut rates if such a move is seen as needed to calm turbulent financial markets.

The International Monetary Fund predicted earlier this year that total losses from the credit crisis could reach almost $1 trillion. So far, banks have only taken about $350 billion in losses.

Commercial banks are also starting to feel the pinch. Eleven have closed so far this year, including Pasadena, Calif.-based IndyMac Bank, which had $32 billion in assets and $19 billion in deposits.

Christopher Whalen, managing director of Institutional Risk Analytics, a research firm, predicts that approximately 110 banks with $850 billion in assets could close by next July. That's out of 8,400 federally insured institutions, he said, which together hold $13 trillion in assets.

Individual customers are starting to get nervous about the financial health of their banks for the first time in generations, he said. Whalen's firm analyzes the safety and soundness of banks for business clients, but began receiving inquiries from individuals in the past two months for the first time, he said.

"If we don't get ahead of this, we are going to face a run on the retail banks by election day," he said.

The Associated Press and Reuters contributed to this report.

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