*Talks to sell Lehman falter, Barclays pulls out
*Concerns grow that bankruptcy filing may be imminent
*Bank of America may buy Merrill -- report
*AIG expected to sell assets --report
*Emergency Sunday trading session set
(Recasts, updates throughout, adds reports on Merrill, AIG)
By Dan Wilchins and Glenn Somerville
NEW YORK/WASHINGTON, Sept 14 The ruptured U.S.
financial system was facing an unprecedented shakeup on Sunday
that could lead to the failure of Lehman Brothers LEH.N, the
takeover of Merrill Lynch & Co Inc MER.N and big asset sales
by big insurer American International Group (AIG.N).
The developments may indicate Wall Street and Washington
are accepting that massive triage is necessary in the face of
the 13-month old credit crisis and destructive U.S. housing
"The U.S. financial system is finding the tectonic plates
underneath its foundation are shifting like they have never
shifted before," said Peter Kenny, managing director at Knight
Equity Markets in Jersey City, New Jersey. "It's a new
financial world on the verge of a complete reorganization."
The focus on Sunday had initially been on whether talks
between regulators and Wall Street's top bankers could lead to
the sale of Lehman, which until recently was the fourth-largest
U.S. investment bank.
However, those talks faltered when Britain's Barclays Plc
(BARC.L), 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 is heading
into bankruptcy and prompted a rare emergency trading session
on Sunday to allow Wall Street dealers in the $455 trillion
derivatives market to reduce their exposure to the firm.
The Lehman news pushed U.S. stock index futures sharply
lower on Sunday, with the S&P500 futures down 36.40 points at
1222.10, and the U.S. dollar tumbled in early trade in New
Zealand, with the euro jumping to 1.4306/10 at 2214 GMT
compared with $1.4225 in late U.S. trade on Friday.
Within hours of Barclays withdrawal, the New York Times was
reporting that Bank of America (BAC.N) was in advanced talks to
acquire Merrill for at least $38.25 billion in stock, citing
people briefed on the negotiations.
And then, the Wall Street Journal said that AIG, which was
until recently the world's largest insurer by market value, is
expected to sell off assets, including a profitable aircraft
REAL ESTATE WOES
Merrill, AIG and Washington Mutual (WM.N), which was the
subject of conflicting reports on Friday about whether it was
in advanced talks for a sale to JPMorgan Chase & Co (JPM.N) all
face similar problems because of their ownership of real-estate
related assets that have fallen sharply in value.
A perception among investors that the losses they have
disclosed are far from enough, and that they will have
difficulty in raising new capital, has driven their share
prices sharply lower.
One of the catalysts for this weekend's events was the
stance of U.S. Treasury Secretary Henry Paulson.
He was strongly opposed to using government money in any
deal aimed at resolving the Lehman crisis, a source familiar
with his thinking reiterated on Sunday.
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.
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.
"This is an extremely, and I stress extremely, rare event.
It also speaks to the more general notion that, in today's
highly disrupted financial markets, the unthinkable is
thinkable," said Mohamed El-Erian, the chief executive of
Pimco, the world's biggest bond fund.
Market sources said the special session was initiated by
the Federal Reserve.
The aim was to reduce risk associated with a potential
bankruptcy filing by Lehman Brothers.
"Trades are contingent on a bankruptcy filing at or before
11:59 p.m. New York time Sunday (0359 GMT)," said the
statement. "If there is no filing, the trades cease to exist."
The special session "is a way to offset the risk between
the remaining large banks and insurance companies and fund
managers prior to the markets opening in Asia," said Mark
Grant, managing director of structured finance at Southwest
Securities, based in Dallas.
Grant is expecting a turbulent session when the U.S.
markets reopen for business on Monday.
"No one has any idea about the credit quality of the assets
in Lehman's portfolio and no one has a handle about the size of
the CDS (credit default swap) contracts," he said.
"The market is going to be spooked. People will be fearful
and no one outside a very small group of people knows what
Lehman going into liquidation will mean."
If there is a forced sale or liquidation, "this could set
off another round of writedowns globally."
Lehman has been collapsing under the weight of toxic
assets, mainly related to real-estate, that are now worth only
a fraction of their original prices.
The crisis at Lehman presented a delicate balancing act for
Paulson and the Federal Reserve, who have urged Wall Street
chiefs to come up with their own solution.
So far this year, the government has sponsored rescues of
Lehman rival Bear Stearns and mortgage lenders Freddie Mac
FRE.N and Fannie Mae FNM.N.
The authorities don't want to be accused of encouraging
excessive risk-taking by bailing out another yet another
But they also cannot afford to let a blow-up of Lehman
paralyze the financial system and deepen the credit crisis.
"Anyone else who has these toxic assets, if they haven't
made a full confession, they better do it now," said Matt
McCormick, portfolio manager at Bahl & Gaynor Investment
Counsel in Cincinnati, Ohio, which has $2.9 billion of assets
"These assets may be hard to unwind, but they can unwind
your firm. Lehman tried to deny reality until the bitter end."
Bankruptcy would mark an ignominious end to a once-proud
firm, founded by cotton-trading German immigrants 158 years
ago. It would also badly tarnish the reputation of CEO Dick
Fuld, who has insisted that his firm could work through its
problems to survive as an independent entity.
One solution that has been considered is a hiving-off of
Lehman's bad assets into a "bad bank", in which rivals would
take stakes, people briefed on the matter said.
It wasn't immediately clear whether such a plan could be
part of a bankruptcy filing.
Former Federal Reserve Chairman Alan Greenspan said on
Sunday 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 told the ABC program "This Week."
"And indeed we shouldn't try to protect every single
institution. The ordinary course of financial change has
winners and losers."
At Lehman's headquarters in midtown Manhattan, employees
were coming and going throughout the day.
Few agreed to be interviewed.
"For some people it's business as usual, but other people
are worried about liquidation and that they won't have jobs,"
commented a man who said he worked in the investment banking
"Some people are upstairs and working on their projects.
Others are worried that they'll be out of work and are packing
up," said the man, who declined to give his name.
Security outside the Fed building where talks between banks
and regulators over the crisis were continuing was even tighter
on Sunday than on Saturday, with nine dark-blue federal
government vans blocking the area around the entrance and
security guards preventing reporters from getting close. By
early evening, some of the executives had left the building but
DIFFERENT THIS TIME
The meetings with the CEOs of Wall Street's top banks were
reminiscent of the 1998 bailout of hedge fund Long-Term Capital
Management, two sources familiar with the situation said.
With LTCM, major banks each contributed to a $3.65 billion
bailout of the hedge fund, allowing it to be wound down in an
This time may be different. The capital of many top banks
is already strained by the credit crisis, making them reluctant
to fork over funds to help Lehman, whose problems are largely a
result of bad bets on the U.S. mortgage market.
Also, while LTCM was a client of most Wall Street firms,
Lehman is a competitor.
Lehman has hired law firm Weil Gotshal & Manges to prepare
a potential bankruptcy filing, the Wall Street Journal reported
on Saturday, citing a person familiar with the matter.