As the outlook for Lehman Brothers appeared to dim Sunday, U.S. and foreign banks joined forces to create a plan aimed at inoculating the global financial system against the investment bank's possible failure, a top investment banking official said.
Banks were in tense talks to create a pool of money worth up to $50 billion to lend troubled financial companies, the official said on condition of anonymity because the discussions were ongoing.
The Federal Reserve announced several initiatives to expand emergency loan programs to cope with the worst credit crisis in decades. The central bank said late Sunday that it was broadening the types of collateral that financial institutions can use to obtain emergency loans from the Fed.
The plan comes as top government officials and Wall Street executives held marathon, but so far fruitless, meetings to save Lehman Brothers, whose shares have tumbled 95 percent in the past year over worries that it does not have enough money to cover losses from its real estate holdings.
The official also said the Treasury Department and the Fed were pushing Bank of America Corp. to buy Merrill Lynch & Co. On Friday, Merrill Lynch's shares fell as investors fretted it might be the next investment bank to come under pressure from its portfolio of risky mortgage-backed securities. Late Sunday, the Wall Street Journal reported on its Web site that the boards of the companies had agreed to a roughly $44 billion acquisition.
Expectations that the 158-year-old Lehman would survive dimmed Sunday afternoon after Barclays PLC withdrew its bid to buy the investment bank. Barclays' and Bank of America were considered front-runners to buy Lehman, which is foundering under the weight of $60 billion in soured real estate holdings.
The Lehman talks originally were aimed at selling the investment bank in whole or in part. The deal was tripping on the potential buyers' insistence that they receive the same kind of help that Bear Stearns Cos.' got last March when JP Morgan Chase & Co. bought the securities firm with a $29 billion Fed-backed loan.
Treasury Secretary Henry Paulson has said the government will not help close a Lehman deal, and it was clear late Sunday he was not budging.
Lehman declined to comment on the talks.
If no deal were reached, it raised the specter of a bankruptcy and liquidation of the investment bank, which in turn could have a tumultuous effect on world markets. Late Sunday, Dow Jones industrial average futures were down 208 points, or 1.8 percent, at 11,250.
Bankers and investment banking officials briefed on the Lehman talks described them as both complicated and fluid. They spoke on condition of anonymity because talks were ongoing.
There were signs that Lehman Brothers might be edging closer to a bankruptcy filing, with several reports that it has hired Weil, Gotshal & Manges, the law firm that handled the collapse of investment firm Drexel Burnham Lambert in 1990.
Moreover, 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 — but that those trades would be voided if no filing occurred before midnight.
Paulson, Timothy Geithner, president of the New York Fed, and Securities and Exchange Commission Chairman Christopher Cox were among those taking part in the Lehman meetings. Federal Reserve Chairman Ben Bernanke is actively engaged in the deliberations but wasn't in attendance.
Paulson's tough bargaining stance received support from outside observers Sunday, who argued that the government had no choice but to draw a line in the sand.
"If Treasury put money into the Lehman deal, then going forward no deal would get done without Treasury help," said Mark Zandi, chief economist at Moody's Economy.com. "Every potential buyer would wait until Treasury stepped in and that would mean Treasury would be on the hook for a lot more bailouts."
The current situation is different from Bear Stearns' situation six months ago.
In Lehman's case, financial markets have been aware of Lehman's problems for a much longer period and have had time to prepare. Investment banks also now have the ability to obtain emergency loans directly from the Fed, a crucial support that they did not have back in March when Bear Stearns was rescued.
In the Lehman talks, bankers and government officials were also trying to tackle a broader agenda that includes problems at American International Group Inc. and Washington Mutual Inc., said the investment bank officials, who were briefed on the talks.
AIG, the world's largest insurer, and WaMu, the nation's biggest savings bank, have taken steep losses during the past year from risky investments. The Wall Street Journal reported Sunday that American International Group Inc. plans to disclose a restructuring by early Monday that's likely to include the disposal of major assets including its aircraft-leasing business and other holdings.
Lehman put itself on the block earlier last week. Bad bets on real-estate holdings — which have factored into bank failures and caused other financial companies to founder — have thrust the firm in peril. It has been dogged by growing doubts about whether other financial institutions would continue to do business with it.
Richard S. Fuld, Lehman's longtime CEO, pitched a plan to shareholders Wednesday that would spin off Lehman's soured real estate holdings into a separately traded company. He would then raise cash by selling a majority stake in the company's unit that manages money for people and institutions. That division includes asset manager Neuberger Berman.