By Sunday night, a series of marathon negotiations over the weekend failed to produce a buyout of Lehman Brothers.
Lehman said in a statement early today that none of its broker-dealer subsidiaries or other units would be included in the Chapter 11 filing in U.S. bankruptcy court in New York.
The investment bank said it is exploring the sale of its broker-dealer operations and is in "advanced discussions" to sell its investment management unit.
After galloping to the rescue of other major financial institutions in recent months, the federal government drew the line with Lehman Brothers, ignoring pleas from would-be buyers who insisted on receiving federal backing for the company's troubled assets. Leaders of the Federal Reserve and Treasury Department decided that Lehman was unlike the investment bank Bear Stearns, whose sudden collapse in March threatened the global financial system, or Fannie Mae and Freddie Mac, whose potential insolvency did the same.
In betting that Lehman, the nation's fourth-largest investment bank, could be allowed to fail without catastrophic consequences, New York Federal Reserve President Timothy Geithner, Fed Chairman Ben Bernanke, and Treasury Secretary Henry Paulson were making it clear that struggling financial firms cannot count on a bailout.
Fed and Treasury policymakers stepped aside to allow a wrenching transformation of Wall Street to proceed. The decision not to intervene carries the big risk that the ripples of Lehman's failure could prove impossible to contain.
The multitrillion-dollar market for "credit default swaps," obscure contracts that act as a form of insurance against corporate failures, could be tested as never before. So would the market for "triparty repo," a form of debt that funds all sorts of financial firms and is held in the money market mutual funds of ordinary Americans, which would also be looking at potential losses from a Lehman bankruptcy.
"Bankruptcy is a perfectly natural thing, but you hope that the firm is in a position so that it can be an orderly bankruptcy and not cause other problems," said Susan Phillips, dean of the George Washington University School of Business and a former Federal Reserve governor.
Indeed, as negotiations for a takeover foundered Sunday, government officials set about trying to bolster those and other markets, calculating the implications a Lehman Brothers failure might have on the rest of the financial system.
The International Swaps and Derivatives Association facilitated a four-hour session Sunday during which traders could sort out positions on credit, equity, interest rate, foreign exchange and commodity derivatives in which Lehman is a party. The results would stand only if Lehman filed for bankruptcy by midnight Sunday, the association announced.
Several firms, especially Bank of America and the British bank Barclays, wanted control of Lehman's investment banking and asset management businesses. However, they wanted no part of billions in shaky real estate and other investments on Lehman's books, and wanted either taxpayers or other financial firms to assume part of that risk.
But other companies decided they didn't want to take on the distressed assets, leaving only the good ones for Bank of America or Barclays.
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