Global markets in turmoil by Lehman failure, Merrill sale

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NEW YORK (Reuters): Global markets plummeted on Monday after investment bank Lehman Brothers filed for bankruptcy protection, rival Merrill Lynch agreed to be taken over and the Federal Reserve threw a life line to the battered financial industry.
As a deepening crisis took new, bigger victims, The US Federal Reserve said 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.
On a black Sunday for Wall Street, frantic attempts to find a rescuer for Lehman failed, and troubled insurer American International Group asked the Fed for a lifeline, according to news reports.
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 becoming the survivors.
Ten of the world's biggest banks on Sunday committed to establish a $70 billion borrowing facility to bolster worldwide liquidity and reduce volatility in what they called an "extraordinary market environment."
Each bank has committed to fund $7.0 billion for the collateralized facility, and any one of the 10 banks would be permitted to borrow up to one-third of the total facility, the banks said in a joint statement. The financing may grow "as other banks are permitted to join," they said.
The 10 banks are: Bank of America Corp, Barclays Plc, Citigroup Inc, Credit Suisse Group, Deutsche Bank AG, Goldman Sachs Group Inc, JPMorgan Chase & Co, Merrill Lynch & Co, Morgan Stanley and UBS AG.
In addition, the banks said they are working together to arrange an "orderly resolution" of derivative exposures between the stricken investment bank Lehman Brothers Holdings Inc and its counterparties.
The 10 banks said their action will be enhanced by the U.S. Federal Reserve's decision to accept a wider array of collateral for emergency loans, including equities for the first time. The Fed also said it would broaden the collateral it would accept from investment banks for direct Fed loans.
Ben Bernanke, the central bank's chairman, in a statement said the Fed's actions, "along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to the markets."
Lehman is widely expected to file for bankruptcy protection after attempts to seek buyers or a bailout failed. Bank of America is expected to announce a $44 billion purchase of Merrill, a person briefed on the matter said.
"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."
Bank of America agreed to buy Merrill Lynch in an all-stock deal worth $50 billion, seeking a bargain as the world's largest retail brokerage sought refuge from fears it could be the next victim.
"It's just shockingly fast how it happened," an employee for Merrill in Asia said. "It's hard to believe there will be no more Merrill Lynch," he said of his firm, known as The Thundering Herd.
Asian and European stock markets tumbled as the worries about Lehman counterparty risk and further financial market turmoil sent investors scurrying for safe havens such as gold.
The FTSEurofirst 300 index of leading European shares fell 5.0 per cent, led by falling bank stocks such as UBS, down 10 percent.
Shares in US banks trading in Frankfurt tumbled, with Lehman plunging 80 per cent and Morgan Stanley, Citigroup and others all in retreat. Frankfurt-listed shares in AIG fell almost 30 per cent.
Merrill's shares offered a rare bright spot and its Frankfurt-based shares jumped 36 per cent. Bank of America said it had agreed to buy Merrill in an all-share deal for the equivalent of $50 billion, or $29 a share, almost $12 a share above Friday's 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 petition followed three days of talks between bank CEOs and regulators at the Fed's fortress-like Manhattan building.
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."
"This shows the US government is saying 'enough' after saving other institutions and that they see Lehman as a private affair. I think today and tomorrow there will be a panic on the markets," said Marie-Pierre Pillon, head of equity and credit research at Groupama Asset Management in Paris.
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.
Meanwhile, The New York Times 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.
Another Reuters report from Perthg said: Oil tumbled below $100 a barrel to a six-month low on early signs that Hurricane Ike may have spared key Gulf Coast infrastructure, although traders were cautious on Monday as they awaited status reports on more Texas refineries.
The upside for oil, which has lost about 32 per cent since its peak of over $147 in mid-July, was also limited as financial woes mounted after talks to rescue Lehman Brothers faltered and Bank of America Corp agreed to buy Merrill Lynch & Co Inc, which has also been struggling with mortgage-related debt.
US light crude for October delivery fell $1.52 or 1.5 per cent to $99.66 a barrel by 0223 GMT. London Brent crude fell $1.23 to $96.35.
US prices dived as low as $98.46 -- the lowest since Feb. 26 -- on Sunday, when the New York Mercantile Exchange held a special trading session due to Hurricane Ike.
If Lehman and Merrill disappear or get taken over, then three of the top five US investment banks would have dissolved or been bought inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.
Oil has fallen steadily since mid-July's peak of over $147 a barrel amid mounting evidence that high energy costs and a weakening economy are cutting deeply into fuel consumption.
Oil firms rushed to their offshore facilities and coastal refineries to check for damage on Sunday after Hurricane Ike's direct hit on the Houston energy hub left a quarter of US oil and refined fuel production idled and millions without power.
Early reports from emergency officials and oil companies indicated little or no severe damage to infrastructure -- signalling a possible quick recovery to production -- but firms warned that supply problems were likely in the near term.
The US Coast Guard said it had received reports of damage to offshore facilities in the Gulf of Mexico, but added details were still not available.