The meltdown

Lehman files for bankruptcy. Merrill is bought by Bank of America. The Fed and major banks expand lending. Anxiety lingers.

NEW YORK (CNNMoney.com) -- Wall Street was a vastly different world Monday from what it looked like just days earlier, following one of the most harrowing days in the history of U.S. financial industry.
In less than a day, Lehman Brothers, one of the nation's oldest investment banks, filed for bankruptcy - the largest ever announced in the United States. And Bank of America executed a bold and swift $50 billion takeover of Merrill Lynch, while the fate of other brand-name financial institutions remained in doubt.
Anxiety was palpable in the financial community Monday. The Dow Jones industrial average plunged more than 2.5% just after the opening bell, before paring some of those losses.
"The magnitude of the surprise fits with what we are seeing in the market today," said Art Hogan, chief market strategist for Jefferies & Co.
Driving much of the fear was a decision by Lehman to file for bankruptcy under Chapter 11 with the U.S. Bankruptcy Court for the Southern District of New York. Lehman, whose fate was in doubt for much of last week, made its intentions known shortly after midnight as talks aimed at saving the 158-year-old firm failed.
Lehman (LEH, Fortune 500) shares, which lost 94% of their value this year as of Friday, were nearly worthless after markets opened Monday.
Different divisions of Lehman offered reassurances to nervous clients Monday. Still, both analysts and rating agencies slashed their assessment of the once-mighty investment bank.
Lehman's endgame capped what proved to be a long weekend for top Wall Street executives and regulators, who held marathon talks to try to craft a rescue plan for the embattled investment bank.
Many had hoped a buyer would emerge, most notably the British bank Barclays or Bank of America. Instead, both suitors pulled out, with Bank of America (BAC, Fortune 500) instead entering merger talks with the brokerage giant Merrill Lynch (MER, Fortune 500). By early Monday, the two had announced that BofA had bought Merrill for $50 billion in stock.
Merrill, known for with its famous bull logo, has been an icon of Wall Street and investing in America. Still, billions in losses in the last year due to fallout in the U.S. mortgage market proved too much for the 94-year old firm.
Certainly, the disappearance of Merrill Lynch and Lehman will result in heavy job losses in the already hard-hit financial services industry.
Lehman Brothers employees, which totaled some 26,000 as of the end of June, were seen carting off their belongings from corporate headquarters in midtown Manhattan as early as Sunday evening. Still, company officials at either Lehman or Merrill provided little indication about how many jobs would be lost as a result of Monday's announcement.
Wall Street firms have lost close to 10,000 jobs, or more than 5% of the work force, so far this year, according to the latest figures from the New York State Department of Labor.
Confident in 'challenging' time
And the fears were not isolated to Lehman. Investors found themselves knee deep in other concerns.
Shares of the insurance giant American International Group (AIG, Fortune 500) lost more than half their value Monday as the market nervously waited for the company to announce a restructuring plan. The move, which was rumored as early as Sunday evening, is expected to include a sale of part of its business to raise desperately needed cash and boost investors' confidence, according to published reports.
The company has suffered steep losses in recent months and now faces the possibility of having its credit rating cut.
Washington Mutual (WM, Fortune 500), the nation's largest savings-and-loan, saw its shares tumble 33% in early trading, amid concerns that it might not have enough capital to ride out the crisis.
Other major financial institutions took pre-emptive steps to try and calm both investors and employees.
Citigroup (C, Fortune 500), which has been one of the hardest hit firms in the ongoing credit crisis due to billions of dollars in losses, stressed the underlying health of the firm Monday morning.
In an internal memo to all Citigroup employees, newly installed CEO Vikram Pandit reiterated the firm's strength and previously announced restructuring efforts aimed at righting the troubled financial firm.
"We are confident about the future despite a very challenging time," Pandit said.
Hoping to provide some comfort to Main Street, President Bush acknowledged the market turmoil Monday, but said that the government was working to correct the problems.
"We are working to reduce disruptions and minimize the impact on the [broader economy]," said Bush, speaking at the White House Rose Garden.
The weekend's developments are certain to result in very real impacts to everyday Americans. Having suffered billions of dollars in losses and more looming ahead, financial institutions will most likely make it more difficult for consumers to gain access to credit including mortgages, auto loans and credit cards and most expensive to boot.
Drastic measures
The Lehman and Bank of America-Merrill news, while important, proved not to be the only development over the weekend.
In order to try and calm the markets, the Federal Reserve announced plans late Sunday to loosen its lending restrictions to the banking industry.
The Fed said it would expand its short-term lending to banks by starting to take all investment-grade debt as collateral - instead of just Treasurys and other high-grade securities.
"The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets," said Fed Chairman Ben Bernanke.
Similarly, a consortium of 10 leading domestic and foreign banks had agreed to create a $70 billion fund to lend to troubled financial firms. The group, which included, among others, Goldman Sachs (GS, Fortune 500), Citigroup, Barclays and Morgan Stanley, agreed to pony up $7 billion each to create a $70 billion lending pool to help troubled institutions.
Treasury Secretary Henry Paulson, who along with Bernanke, has spearheaded efforts to help get the U.S. housing market and the broader economy back on track, applauded the steps taken by regulators and top banking executives.
"These initiatives will be critical to facilitating liquid, smooth functioning markets, and addressing potential concerns in the credit markets," Paulson said in a statement.
During the weekend talks, the Treasury Department stressed its opposition to using any government money to help finance a takeover, restructuring or bailout of Lehman.
Top banking regulators, including the Federal Reserve, faced heavy criticism from lawmakers following the bailout of Bear Stearns in mid-March.
The Fed helped engineer a fire sale of the firm to JPMorgan Chase (JPM, Fortune 500), agreeing to put taxpayer funds at risk by guaranteeing $29 billion's worth of potential losses on Bear Stearns' portfolio.
Sunday's news also garnered attention from the campaign trail, as both candidates weighed in. Sen. John McCain praised the Fed and the Treasury for avoiding engaging in a bailout of Wall Street, blaming the Lehman collapse on "ineffective regulation and management."
Sen. Barack Obama called the developments "troubling," stressing the need to modernize regulation that oversees both Wall Street and broader financial markets