RPT-WRAPUP 7-Wall Street shaken by Lehman failure, Merrill sale

REAL ESTATE WOES

Merrill, AIG and Washington Mutual WM.N, the biggest savings and loan institution -- which was the subject of conflicting reports on Friday about whether it was in advanced talks for a sale to JPMorgan -- have faced similar problems.

They have held large amounts of real-estate related assets that have fallen sharply in value. Shares of all three lost more than one-third of their value last week.

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 real-estate, that are now worth only a fraction of their original prices.

One of the catalysts for this weekend's events was the stance of U.S. Treasury Secretary Henry Paulson, who opposed 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 (FRE.N) and Fannie Mae (FNM.N).

The authorities didn't 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.

Hence the Fed's moves and soothing words from SEC Chairman Christopher Cox, who said the regulator will take steps to "reduce the potential for dislocations from recent events."

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.

Paulson, who worked throughout the weekend in New York in the bid to find a suitor for Lehman, praised bankers for putting up the $70 billion in a special fund to provide another source of liquidity as Lehman is shuttered.

IGNOMINIOUS END

Whether it will be enough to keep markets stable is another question.