Markets in Turmoil by Lehman Failure and Merrill Sale - Financial Markets Shake Up

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 emerged as a front-runner to buy Lehman late on Sunday after Bank of America pulled back, but it was deterred by the U.S. government's unwillingness to provide a financial backstop to potential losses.

Lehman collapsed under the weight of toxic assets, mainly related to real estate, that are now worth only a fraction of their original prices.

In its bankruptcy filing, Lehman said Citigroup, Bank of New York Mellon, Japan's Aozora Bank and Mizuho Financial Group were among its top unsecured creditors.

The cost of insuring banks against default jumped and one credit analyst said without the positive Merrill takeover news the market could have seen "one of the most brutal days on record."

LINE IN SAND

Lehman employees streaming into its European headquarters in London's Canary Wharf financial district were met by television cameras, a swarm of reporters and a beefed-up security team.

"I guess times are tough and we've got to face the music ... Everyone is worried about their job, it's inevitable," said one banker entering the building, adding a company-wide meeting had been set for Monday morning.

Other employees said staff were clearing desks, packing personal belongings and saying farewells to colleagues.

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.

The New York Times also reported that AIG, once the world's largest insurer, had made an approach to the Federal Reserve 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 for direct Fed loans, it 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 lenders Freddie Mac and Fannie Mae, wary of accusation of encouraging excessive risk-taking by bailing out the bank.

(Additional reporting by Steve Slater, Sitaraman Shankar, Brian Gorman, Jane Baird and Olesya Dmitracova in London; Editing by Andrew Callus and Maureen Bavdek)

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