Wall Street on alert
Lehman says it will file for bankruptcy. Fed and 10 strong banks expand 
lending to weaker players. Plus: Merrill and Bank of America close to deal.
By David Ellis, CNNMoney.com staff writer
Last Updated: September 15, 2008: 1:42 AM EDT
NEW YORK (CNNMoney.com) -- After enduring one of the most dramatic days in 
its history, Wall Street received a climactic jolt on Monday when Lehman 
Brothers, a 158-year-old investment bank undermined by bad bets on real 
estate, said it will file for bankruptcy.

The fall of Lehman followed a wild, three-day scramble by top Wall Street 
executives and federal regulators who worked around the clock to come up 
with a solution to a still-unfolding financial crisis.

By the end of the weekend, the Federal Reserve had stepped in to try to calm 
the markets by announcing plans to loosen its lending restrictions to the 
banking industry. A consortium of 10 leading domestic and foreign banks had 
agreed to create a $70 billion fund to lend to troubled financial firms. And 
two major financial companies - Bank of America (BAC, Fortune 500) and 
Merrill Lynch (MER, Fortune 500) - were finalizing a merger while another - 
American International Group - was reportedly struggling to secure billions 
of dollars in capital.

But it was the fate of Lehman (LEH, Fortune 500) that gripped Wall Street. 
After weeks of speculation about its health, Lehman's fate took a turn for 
the worse Sunday when Bank of America and British bank Barclays, both viewed 
as potential "white knights," pulled out of deal talks, according to 
sources.

"This looks like the end," a Lehman executive, who declined to be 
identified, told Fortune on Sunday afternoon.

So Bank of America turned to merger talks with Merrill. Both the Wall Street 
Journal and the New York Times reported that a deal, which could be worth 
about $40 billion, was all but finalized.

Hours before Bank of America pulled out, Barclays had abandoned talks to buy 
Lehman, a source close to the situation told CNNMoney.com.

All the while, top Wall Street officials and federal regulators, who began 
meeting Friday, spent much of their Sunday at the Federal Reserve Bank of 
New York in the hopes of devising a plan to save Lehman and allay fears that 
threatened to roil U.S. financial markets Monday.

Meanwhile, broader efforts to tackle problems plaguing the entire industry 
are underway.

The Federal Reserve announced a series of steps to support the financial 
markets. The Fed said it would expand its short-term lending to banks by 
starting to take all investment-grade debt as collateral - instead of just 
Treasurys and other high-grade securities.

"The steps we are announcing today, along with significant commitments from 
the private sector, are intended to mitigate the potential risks and 
disruptions to markets," said Fed Chairman Ben Bernanke.

Similarly, a group of 10 commercial and investment banks including, among 
others, Goldman Sachs (GS, Fortune 500), Citigroup, Barclays and Morgan 
Stanley, agreed to pony up $7 billion each to create a $70 billion lending 
pool to help troubled institutions.

The measure would also help resolve exposure between Lehman Brothers and its 
counterparties, the companies said.

Treasury Secretary Henry Paulson, who has led efforts to help get the U.S. 
housing market and the broader economy back on track, applauded the plan and 
steps taken by regulators.

"These initiatives will be critical to facilitating liquid, smooth 
functioning markets, and addressing potential concerns in the credit 
markets," Paulson said in a statement.

Yet the last-minute efforts provided little comfort to financial markets 
around the globe. As of Sunday evening, U.S. markets were headed for a steep 
selloff at the start of Monday's session.

Futures in the Dow Jones industrial average, as well as the broader Nasdaq 
composite and the Standard & Poor's 500 were as much as 3% lower, before 
paring some of their losses.

Investors already started piling into safe-haven Treasuries as the yield on 
the benchmark 10-year note dipped to 3.565% from 3.72% late Friday.

That nervousness also spread to the currency markets as the dollar eased 
against both the euro and the yen.

Adding to those concerns was news that insurance giant AIG (AIG, Fortune 
500) planned to unveil a restructuring plan that will include the sale of 
part of its business to raise cash and boost investors' confidence, 
according to a published report.

Investors are also likely to await more data about troubled savings and loan 
Washington Mutual (WM, Fortune 500), which sought to provide assurance about 
capital levels on Thursday.

What could help temper a market selloff is the widely-anticipated Bank of 
America-Merrill deal, said one expert.

"This sort of offsets the Lehman thing," said Dan Alpert, managing director 
of the boutique New York City-based investment bank Westwood Capital. "But 
the reality is that it is just a short-term impact."

Lehman dark and light
Still, much of the market's focus ahead of Monday was on the endgame for 
Lehman. The hope was that some solution could be found by early Monday 
morning in the U.S. - before financial markets open in Europe. Most Asian 
markets are closed for a holiday Monday.

But the abandonment of Barclays and Bank of America left Lehman Brothers 
teetering.

During the afternoon, and adding to the dark cloud hanging over Lehman, the 
International Swaps and Derivatives Association staged a special trading 
session so that big brokers could limit their Lehman Brothers risks.

The session was called "to reduce risk associated with a potential Lehman 
Brothers Holding Inc. bankruptcy," according to a statement on the ISDA's 
Web site.

Lehman - one of the nation's largest and oldest investment banks - has 
suffered a dramatic and rapid descent. Its shares, which sold for as much as 
$67 in the past 12 months, have plummeted 94% this year and now trade at 
$3.65.

In the past six months, the company reported $6.7 billion in losses due 
largely to bad bets on real estate.

In its bankruptcy announcement Monday, Lehman said that its board had OK'd 
the filing "to protect ... assets and maximize value." None of Lehman's 
broker-dealer subsidiaries will be included in the Chapter 11 petition, the 
firm's announcement said. Lehman said it is trying to sell its broker-dealer 
business and is in "advanced discussions" to unload its investment 
management division.

Race against the clock
A source with knowledge of this weekend's meetings told CNN that 
representatives of several major financial institutions met with Paulson, 
Securities and Exchange Commission Chairman Christopher Cox and New York 
Federal Reserve Bank President Timothy Geithner to discuss Lehman and the 
volatile state of the financial markets.

On Saturday, several heads of big Wall Street banks, including Merrill Lynch 
CEO John Thain, were seen entering and leaving the offices of The Federal 
Reserve Bank of New York.

According to several reports, other financial firms were said to be 
reluctant to contribute their own funds to help keep Lehman's more toxic 
assets afloat without the assurance that the government would backstop 
Lehman's bad loans.

However, a source close to the situation told CNN Friday that the Treasury 
Department was adamantly against using any government money to help finance 
a takeover, restructuring or bailout of Lehman.

Top banking regulators, including the Federal Reserve, faced heavy criticism 
from lawmakers following the bailout of Bear Stearns in mid-March.

The Fed helped engineer a fire sale of the firm to JPMorgan Chase (JPM, 
Fortune 500), agreeing to put taxpayer funds at risk by guaranteeing $29 
billion's worth of potential losses on Bear Stearns' portfolio.

A chaotic week for Lehman and Wall Street
The talks followed what has been one of the most tumultuous weeks ever on 
Wall Street.

Things first started to unravel at Lehman Tuesday following reports that 
talks between the state-run Korea Development Bank, who was rumored to be 
interested in buying a stake in Lehman, had ended.

That, combined with the threat of a downgrade by some of the credit ratings 
agencies, led to a bloody sell-off in the firm's stock.

Hoping to finally put all the rumors to rest, the company released its 
third-quarter results more than a week in advance on Wednesday, booking a 
nearly $4 billion loss and announcing a drastic restructuring plan. 
Investors were unconvinced though and the sell-off in Lehman shares 
continued, with the stock plunging 42% on Wednesday.

By Thursday evening, it was widely reported that Lehman was actively seeking 
a buyer for the entire firm. The company reportedly reached out to a number 
of suitors, including Bank of America and Barclays.

Speculation also surfaced Friday that J.C. Flowers & Co. and other private 
equity firms may bid for all or parts of Lehman. Current regulatory 
restrictions prevent buyout firms from owning a bank outright, although the 
Federal Reserve has eyed loosening those restrictions as bank failures pile 
up.

But as Friday wore on without any news of a deal, Lehman's stock wound up 
falling another 13.5%. Shares plunged 77% over the course of the week, 
setting the stage for regulators to call upon banking executives to get 
together Friday night and begin talking about ways to hash out an end to the 
Lehman crisis.

End of an era for Wall Street icon
Lehman's bankruptcy marks a bitter coda for one of Wall Street's oldest and 
most well-known firms. Getting its start as a modest cotton-trading firm in 
Montgomery, Ala., in 1850 by German immigrant brothers Henry, Emanuel and 
Mayer Lehman, the firm saw its fortunes rose and fell along with the rest of 
Wall Street.

After World War II, Lehman's profile grew as it advised such household 
American companies as Ford, Campbell Soup and Philip Morris on deals, before 
expanding overseas into Europe and Asia in the 1960s and 1970s.

The firm also became a breeding ground for high-profile dealmakers. Both 
Steve Schwarzman and Pete Peterson, co-founders of the private equity giant 
Blackstone Group, worked for Lehman in the early 1980s.

But Lehman's rise was cut short in April 1984, when the company agreed to be 
purchased by Shearson/American Express for $360 million. The company emerged 
independent just seven years later, albeit in much weaker shape than it was 
before.

It was around that time, however, that CEO Richard Fuld Jr., assumed the 
helm at Lehman and the firm went public after splitting off from American 
Express.

Known for his direct approach and staunch loyalty to the firm, Fuld 
transformed Lehman in the decade that followed from a lowly bond trading 
house into a worthy adversary of larger investment banks Goldman Sachs and 
Morgan Stanley.

Still there were bumps along the way for the long-time Lehman chief, 
including the Russian credit crisis and the painful collapse of the hedge 
fund Long-Term Capital Management in the late 1990s.

Fuld was quick to remind investors of those painful days and subsequent 
comeback during a conference call Wednesday, just after the company revealed 
its nearly $4 billion third-quarter loss.

"This firm has a history based on adversity and delivering," said Fuld. "We 
have a long track record of pulling together when times are tough."

But the obstacles Lehman faced this time around proved too tough for Fuld to 
overcome.