The Federal Reserve Bank of New York held emergency talks with officials of major Wall Street firms on Friday night as concerns grew that Lehman Brothers Holdings Inc. may fail to find a willing buyer to save the ailing institution.
Lehman executives, potential buyers and government officials struggled through Friday to craft a buyout plan as investors anticipated a weekend of last-ditch efforts to limit fallout from the latest victim of the global credit crunch.
"Senior representatives of major financial markets met at the Federal Reserve of New York Friday evening to discuss recent market developments," a Fed official told Reuters.
The bank officials reviewed their exposure to Lehman with an eye to developing contingency plans, including an orderly liquidation of the firm if no buyers were found, the Times reported, citing people briefed on the situation.
"The Fed is trying get this thing sorted out," Mark Waggoner, president of Excel Futures Inc. of Huntington Beach, California, said when told of the meeting. "They are worried about a domino effect."
Fears about the health of the US banking system hurt shares of Wall Street financial institutions on Friday, limiting gains in the broader stock market and pushing the US dollar lower. Lehman shares closed at a 14-year low as traders increasingly came to the belief that the US government would not provide financial backing for a deal.
A source familiar with the thinking of the Treasury Secretary said earlier in the day Paulson was "adamant" that no public funds be put on the line to help facilitate a sale.
Bank of America is widely seen as a leading contender, with Barclays plc also considered a possibility. Time is of the essence for Lehman. Since Monday, the firm's market capitalisation has lost 78 per cent, to about $2.5 billion from $11.2 billion. Its shares fell 13.5 per cent on Friday to close at $3.65 on the New York Stock Exchange. Its bonds also dropped.
The uncertainty surrounding Lehman underscores how the US banking system as a whole does not have the capital needed to get through the current credit crunch, an influential investor said on Friday.
Other financial companies' shares also plunged on Friday, including leading brokerage Merrill Lynch & Co Inc. and American International Group Inc., once the world's largest insurer by market capitalisation. AIG lost as much as a third of its value, while Merrill slid 11 per cent.
Credit protection costs also rose for AIG, Lehman and JPMorgan Chase & Co, with investors paying $715,000 to protect $10 million of Lehman debt, and $1.2 million to protect the same amount of AIG debt.
The Financial Times reported that Bank of America, the No. 2 US bank by assets, was considering a joint bid for Lehman along with private equity investor JC Flowers and sovereign wealth fund China Investment Co. Lehman declined to comment.
Lehman's survival may hinge on the sale of a 55 per cent stake in Neuberger Berman, its asset management business.
Bids for the asset, due on Friday, were put in by private equity firms including Bain Capital and Clayton, Dubilier & Rice, sources said. Buyout firms Kohlberg Kravis Roberts and Hellman & Friedman have also been pursuing the unit and were expected to bid, sources previously told Reuters.
Senator Richard Shelby, the top Republican on the Senate Banking Committee, told CNBC that the Treasury and the Fed were trying to work a deal that involved no US government money. "I'm hoping that some big firm will want them more than the Fed wants them," he said.
The investment bank is struggling to find a solution to the worst crisis of its 158-year history. Lehman wrote down its assets by $5.6 billion in the third quarter, triggering a second straight quarterly loss.
Lehman has so far failed to attract investors to shore up its capital position, weakened this year by its outsized exposure to commercial real estate and residential mortgage assets hard hit by the continuing credit crunch.
The government's reluctance to intervene has raised concern about the possibility of a Lehman bankruptcy filing. If Lehman, which employs 25,935 people worldwide, did go under, the effects could be devastating to world markets, resulting in a fire sale of its troubled assets that could depress bond and mortgage markets, among other areas.
Bank of America and other bidders were said to be concerned about potential losses on Lehman's $45.8 billion of mortgage and asset-backed securities.
Lehman chief executive Richard Fuld, who had vowed never to sell the firm in his lifetime, has been trying to unload just a part of the company rather than the whole thing, sources said.