Big changes in financial landscape

Merrill sold; Lehman to file for bankruptcy

A series of meetings over the weekend at the Federal Reserve Bank of New York resulted in a failed plan to rescue Lehman Brothers and a deal by Bank of America to buy the investment bank Merrill Lynch. A series of meetings over the weekend at the Federal Reserve Bank of New York resulted in a failed plan to rescue Lehman Brothers and a deal by Bank of America to buy the investment bank Merrill Lynch. (David Karp/Associated Press)
By David Cho and Binyamin Appelbaum
Washington Post / September 15, 2008
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WASHINGTON - Bank of America, the nation's largest bank, swung a deal late yesterday to buy the venerable investment bank Merrill Lynch, the nation's largest retail brokerage, according to sources familiar with the matter.

The acquisition capped a frenzied weekend in which top Wall Street leaders and regulators also allowed Lehman Brothers to head toward liquidation and assisted American International Group.

Early this morning, Lehman Brothers said on its website it would file for Chapter 11 bankruptcy for its holding company, while allowing its subsidiaries to remain solvent. The filing would represent the largest failure of an investment bank since Drexel Burnham Lambert collapsed 18 years ago.

Leaders of AIG, the nation's largest insurance company, were scrambling to pull together a sweeping restructuring plan to save their firm, said sources who spoke on condition of anonymity because of the fluid nature of the unfolding events.

These massive shifts in the financial industry came together during an extraordinary series of meetings over the weekend at the Federal Reserve Bank of New York. They included senior executives of every major Wall Street firm as well as officials from the Fed, Treasury Department, and Securities and Exchange Commission. Participants described the meetings as hectic and unpredictable, with at least two big deals to buy Lehman coming together and falling apart in a matter of hours. Problems at Washington Mutual, the nation's largest thrift, as well as major flaws in the architecture of the financial markets, were also discussed.

At the meetings, some of the biggest names in banking faced a reckoning for taking on too much debt and betting too much money on risky mortgage loans. At the same time that Lehman appeared to be headed for a bankruptcy, the 94-year-old Merrill Lynch agreed to merge with Bank of America.

Last night, Merrill's board accepted a $29-per-share offer, which is about half of what the stock was worth at the beginning of 2007. That values the deal at more than $40 billion. On Friday, Merrill closed at $17.05.

The Wall Street firms pushed hard for the government to put in money to save the sinking ships. During the long discussions, Timothy Geithner, president of the Federal Reserve Bank of New York; Treasury Secretary Henry Paulson, a former Goldman Sachs chief executive; and Ben Bernanke, the Fed chairman, insisted there would be no bailout. That stance ensured that Wall Street would look radically different, participants said.

Tying the troubles together at all of the firms in attendance were the mortgage bonds that financed homeownership for millions of Americans during the housing boom over the past several years. The biggest Wall Street banks, more than any other type of financial firm, rushed into this profitable business with few foreseeing the far-reaching effects of a real estate crash. Now it is clear that the losses from these bonds can take down giants.

The most recent round of cascading problems was sparked by Lehman. Its bankruptcy filing has the potential to spread across the financial system because other firms held similar securities.

According to The New York Times, Lehman's filing is expected to be significantly different from those of other firms seeking Chapter 11 bankruptcy protection. Because of the harsher treatment that bankruptcy law applies to financial-services firms, Lehman cannot reorganize and survive. It was not clear whether the government would appoint a trustee to supervise the liquidation of the holding company, even as its subsidiaries, such as Neuberger Berman Holdings, continue to trade.

Merrill was one of the largest producers and sellers of collateralized debt obligations, which are securities that package a large number of mortgage bonds and sell them to investors. Merrill and other Wall Street banks made many more of these collateralized debt obligations than they could sell. As mortgage defaults started to rise, the value of their obligations plummeted. The losses threatened Merrill's survival. Merrill's shares dropped 36 percent last week, reducing its market value by $15 billion, to $26 billion.

Bank of America, in contrast, remains relatively strong because its core banking business is healthy. As a result, it was one of the few bidders at what is turning out to be a historic fire sale.

Initially, Bank of America emerged as a suitor for Lehman but backed out after federal regulators refused to put government money behind the deal.

The bank may view Merrill as a better fit because it runs the nation's largest retail brokerage. Bank of America, already the nation's largest seller of credit cards and home mortgages, has long coveted a larger role in the business of selling investments and managing wealth but struggled building its own investment bank. As the mortgage market has melted down, AIG has been on the line to cover more of the losses, eating away at the firm's capital. Over the last nine months, AIG has posted $18.5 billion in losses. Last week, its shares fell sharply on fears that it would have to raise tens of billions of dollars more capital.

The plan tomorrow is probably going to include selling subsidiaries, according to sources familiar with the restructuring.

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