By Dan Wilchins and Jennifer Ablan
NEW YORK (Reuters) - American International Group
AIG's struggles followed the failure of frantic attempts to
find a rescuer for investment bank Lehman Brothers Holdings Inc
Reports said AIG, once the world's largest insurer, had asked the Federal Reserve for an emergency loan over the weekend, and the company was now the focus of attention as it plotted a way out of a liquidity crisis caused by massive losses from guaranteeing bad mortgage investments.
U.S. stocks fell sharply across the board, but not as much as some expected, after one of the most turbulent days in Wall Street history.
As a deepening crisis took new, bigger victims, the Fed said that for the first time it would 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.
The Dow Jones industrial average was down 2.4 percent in early-afternoon trading, while the Standard & Poor's 500 Index lost 2.3 percent.
Lehman shares fell more than 90 percent to 26 cents.
The events signal a seismic shift in Wall Street's power
structure, with big name investment banks biting the dust and
major banks like Bank of America and JPMorgan Chase
"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."
MERRILL SELLS, LEHMAN EXITS
Bank of America agreed to buy Merrill Lynch
Bank of America was seeking a bargain, and the world's largest retail brokerage, known as The Thundering Herd, was seeking refuge from fears it could be the next victim.
"It's just shockingly fast how it happened," a Merrill employee in Asia said. "It's hard to believe there will be no more Merrill Lynch."
Shares of U.S. banks tumbled in the wake of the Lehman
news, with Washington Mutual
Merrill shares jumped 28 percent to $21.85. The Bank of America offer was worth $29 a share when it was announced, almost $12 above Merrill's Friday closing price.
Lehman said it filed for Chapter 11 bankruptcy protection and was attempting to sell assets, becoming Wall Street's highest-profile bankruptcy since junk bond specialist Drexel Burnham Lambert succumbed in 1990. Lehman's European arm appointed administrators, who said they would wind down the business in as orderly a manner as possible.
Lehman's bankruptcy petition followed three days of talks between bank CEOs and regulators at the Fed's fortress-like Manhattan building.
"This shows the U.S. government is saying 'enough' after saving other institutions, and that they see Lehman as a private affair," said Marie-Pierre Pillon, head of equity and credit research at Groupama Asset Management in Paris. "I think today and tomorrow there will be a panic on the markets."
The euro jumped as high as $1.4479, up 1.7 percent from Friday, and 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 that the Fed will cut interest rates. The euro later weakened to $1.4191.
SHAKE-UP
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
Lehman collapsed under the weight of toxic assets, mainly related to real estate, that are now worth only a fraction of their original prices.
The cost of insuring banks against default jumped. One credit analyst said that without the positive Merrill takeover news, the market could have seen "one of the most brutal days on record."
LINE IN THE SAND
Scores of Lehman employees began showing up at dawn at the company's New York headquarters, many dressed in casual clothes. Most were carrying duffel bags and suitcases, as if they were planning to pack up and leave. A companywide meeting is set for later in the day, one said.
Merrill workers were also uncertain about their future.
"Everybody has been shellshocked," a Merrill trader said on his way into the headquarters building. "Nobody thought we'd be bought by Bank of America in a million years. At least we won't be bankrupt. It should be a interesting day at work."
AIG could be the next U.S. financial giant to run into serious trouble. The New York Times reported that the company had made an approach to the Fed seeking $40 billion in short-term financing.
Authorities sought to prop up market confidence with announcements late on Sunday. The Fed said it would accept equities as collateral for emergency loans, and laid out a series of steps to calm markets and brace for Lehman's collapse.
In addition to broadening the collateral it will accept from investment banks in exchange for direct loans, the Fed 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 after a
week earlier bailing out mortgage finance companies Freddie Mac
(Additional reporting by Steve Slater, Sitaraman Shankar, Brian Gorman, Jane Baird and Olesya Dmitracova in London; Editing by Maureen Bavdek and John Wallace)
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