[legion]

Part II:

But Merrill's clients, too, were beginning to pull out money. The firm's stock was sinking. Executives, including Merrill President Gregory Fleming, were nervous.

Mr. Fleming believed he'd identified the ideal partner for Merrill. Bank of America, with a strong balance sheet and retail operations, would mesh well with Merrill's securities franchise and 16,000-strong brokerage force. Mr. Fleming worried that Bank of America could buy Lehman instead.

Mr. Fleming called a long-time lawyer for Bank of America, Edward Herlihy of Wachtell, Lipton, Rosen & Katz. "You have to talk to us," Mr. Fleming said. He was told that Merrill's Mr. Thain would have to approach Bank of America's Mr. Lewis. "I know," Mr. Fleming responded. "I'm gonna try."

At 5 p.m. Friday, after a day of massive client withdrawals at Lehman, Mr. Thain's phone rang. It was the Treasury. "Be at the Fed at 6 p.m.," Mr. Thain was told.

Soon after, Mr. Thain gathered along with Morgan's Mr. Mack and Goldman's Mr. Blankfein at the New York Federal Reserve in downtown Manhattan, in a room once used to cash coupons on Treasury bills. The three men were greeted by the masters of the world's biggest economy -- Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, New York Fed Chief Timothy Geithner and Securities and Exchange Commission chief Christopher Cox. It was a signal moment for the Wall Street firms, which after years of being monitored by the SEC would all soon come under the regulatory watch of a newly powerful Fed.

The federal officials told the Wall Street chiefs to return in the morning. If the mess at Lehman could be fixed, it would be the job of the Wall Street bosses. There would be no public bailout.

An industry-led solution wouldn't be without precedent. In the market panic of 1907, financier J.P. Morgan persuaded fellow bankers to help fund a bailout for failing rivals. Competitors united again in 1998, putting up money to insulate the financial system from the failure of hedge fund Long Term Capital Management.

But now, Mr. Fuld's problems at Lehman were possibly beyond repair.

By that night, Bank of America's team had concluded that Lehman's real-estate portfolio was worse than expected -- and as a result, the firm's liabilities likely exceeded its assets. "We need government assistance, and we are not getting it," the bank's top deal maker, Greg Curl, told his group. Some of the negotiators prepared to fly back early the next morning to headquarters in Charlotte.

Mr. Lewis hadn't come to New York for the Lehman talks. He called Mr. Fuld from Charlotte, telling him that Bank of America couldn't do a deal without federal help. "We will keep a team in New York in case things change," Mr. Lewis told him.

Saturday, Sept. 13

Mr. Fuld arrived at Lehman's office at 7 a.m. on Saturday, wearing a blue suit and tie. The talks with Barclays were still moving. If the government could be moved, there could also be hope for a Bank of America deal.

Merrill, meanwhile, was beginning its own pursuit of Bank of America.

At his home in Rye, N.Y., Mr. Thain was getting dressed for a day at the New York Fed when his phone rang. It was Merrill's president, Mr. Fleming.

"John, you really need to call Ken Lewis," Mr. Fleming said.

"Get me his number," said Mr. Thain, who added it to his papers for the day.

Mr. Thain's black SUV pulled up in front of the New York Fed just before 8 a.m. Top executives from all four investment banks -- minus Lehman's Mr. Fuld -- were there.

Federal officials broke Messrs. Thain, Mack and Blankfein and their top aides into groups. One studied the potential fallout from a Lehman failure. Another was charged with putting a value on Lehman's controversial real-estate investments. A third group, which included Mr. Thain and Morgan's Mr. Mack, was supposed to discuss an industry-led bailout for Lehman.

Lehman's president, Bart McDade, walked the group through the embattled firm's books. Mr. McDade did not respond to requests for comment for this article.

Mr. Mack questioned Wall Street's ability to repair markets. The firms could try to backstop Lehman, he argued, but there was no guarantee they wouldn't have to rescue another rival later. "If we're going to do this deal, where does it end?" he said.

As Mr. McDade discussed Lehman's position, Mr. Thain had an epiphany: "This could be me sitting here next Friday."

Mr. Thain pushed his chair back and left the group to caucus with top Merrill officers. "Lehman is not going to make it," he told them.

Mr. Thain stepped to a sidewalk behind the New York Fed and called the Bank of America chief at his home in Charlotte. "I can be there in a few hours," Mr. Lewis said.

Members of Bank of America's deal team, exhausted from scrutinizing Lehman's books, had just landed in Charlotte. Mr. Lewis ordered them back to New York.

Up in Lehman's midtown office, Mr. Fuld was also dialing Mr. Lewis's North Carolina home. His calls went unreturned. "I can't believe that son of a ***** won't return my calls," he told a top adviser.

Lehman's bankruptcy team, meanwhile, was rolling into action. Shortly before noon, Mr. Miller, the Weil Gotshal bankruptcy head, sent an email to several partners. Lehman's name didn't appear in the email. Its subject line read: "Urgent. Code name: Equinox. Have desperate need for help on an emergency situation."

Throughout the day, Mr. Miller's attorneys, working with Federal Reserve officials and their attorneys, began seeking information from Lehman. But with Lehman's top officials tied up at the Fed and in Barclays negotiations, the lawyers were hard-pressed to get the details they needed.

"We were a distraction to the Lehman people," said Lori Fife, a Weil partner. "It felt like it was just a fire drill."

Later that afternoon, Merrill's chief executive met Bank of America's CEO, Mr. Lewis, in the bank's corporate apartment in the Time Warner Center. In a one-on-one meeting overlooking Central Park, the two men agreed that it looked like Lehman would be forced into bankruptcy.

Mr. Thain made his opening offer. "How about buying a 9.9% stake" in Merrill, he proposed.

Mr. Lewis said the bank doesn't tend to buy minority stakes. He suggested Bank of America could buy the whole firm.

"I am not here to sell Merrill Lynch," Mr. Thain responded.

"Well, that is what I want," Mr. Lewis countered.

The two parted with an agreement to keep talking.

Lehman's talks with Barclays, meanwhile, were moving forward at the New York Fed, under the eye of government officials. "Shouldn't I be there?" Mr. Fuld said to Lehman President Mr. McDade and to attorney Rodgin Cohen of Sullivan & Cromwell LLP, a longtime adviser.

What Mr. Fuld appeared not to know was that some top government officials had instructed key Lehman representatives at the Fed building to keep Mr. Fuld away that weekend. The federal officials had explained that Mr. Fuld -- not only Wall Street's longest-serving boss, but a director of the New York Fed -- could be an unnecessary distraction and a lightning rod for criticism.

At the Fed meetings, much of the talk was on the sidelines. When Mr. Thain returned to the New York Fed from his discussions with Mr. Lewis, Merrill advisers told him they had been approached by top Goldman executives. The rival house was interested in taking a 9.9% stake in Merrill and offered to extend a $10 billion line of credit.

Mr. Thain was digesting the news when he was approached by Mr. Mack of Morgan Stanley. "We should talk," Mr. Mack said. The bosses of Merrill and Morgan agreed to meet that evening. Soon, Mr. Thain and two advisers were en route to the Upper East Side apartment of a Morgan co-president.

Mr. Thain drank a Diet Coke as the Morgan and Merrill executives talked. Both sides felt there were benefits to merging. Mr. Thain indicated he needed a deal quickly. The meeting ended without a firm plan. "We have a board meeting Tuesday and can get back to you soon," Mr. Mack said before the group broke up.

As Mr. Thain and his advisers left the apartment, the Merrill chief suggested he had faint hopes for a deal with Morgan Stanley. "I don't think they share our sense of urgency," he said.

Merrill's talks with Bank of America, however, were on track at the bank's law firm, Wachtell Lipton. Merrill's team was camped out on Wachtell's 34th floor. Bank of America's team was on the 33rd. Around midnight, Mr. Lewis left the law firm for his apartment in the Time Warner Center. Pizza arrived at Wachtell at 3 a.m.

At Lehman's offices that evening, Mr. Fuld still hadn't heard back from Mr. Lewis. Attorneys from Weil were poring through documents, drawing up what would be the largest bankruptcy in U.S. history.

But in a rare piece of good news for Lehman, Barclays had agreed to buy Lehman, as long as it didn't have to take on its soured real-estate assets. Lehman's asset-management division would also be spun off. The Fed indicated that a syndicate of banks and brokers had agreed in principle to put up enough capital to support a separate company that would hold Lehman's bad real-estate assets.