Bracing for the Big One

Suddenly, the term "too big to fail" is off the table. With Lehman Brothers likely to go into bankruptcy, Wall Street is preparing for a very rocky trading day. We'll get a hint of what's in store in a few hours when Asian markets open for business. Already, there's been an emergency trading session at the International Swaps and Derivatives Association to "reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy." The ISDA was allowing customers to make trades and unwind positions linked to Lehman. The problem is that the financial world is inexorably intertwined - so much so that trying to decouple may prove perilous.

That's why banks like Lehman and Bear Stearns and Merrill Lynch were deemed "too big to fail." The presumption was that the government would intervene for the greater good. But after the Bear Stearns purchase by JP Morgan - hastily arranged by the feds - Wall Street and Washington came under fire for bailing out a company that by all rights should have gone under. This raised the issue of "moral hazard" - the idea that a business insulated from the risk of failure may behave differently than if it were exposed to the "hazard." In this case, investment banks were getting themselves knee deep in high-stakes real estate-related derivatives that provided a much higher return than standard government securities. For a while this weekend, when Barclays was nearing a deal to purchase Lehman's better-performing assets, it appeared as if the government would provide some sort of support (but nothing that involved taxpayer money). Now the Barclays deal is dead, for reasons still unclear.

The question is what will happen when Lehman liquidates? The fear is that it might set off a chain of additional Wall Street failures that could derail the financial world. No one knows how it might play out because nothing quite like this has ever happened. That could explain why Merrill Lynch is having serious talks with Bank of America. All the vulnerable players want to batten down the hatches.

Here are the latest writethrus from the WSJ and Bloomberg. Be aware that this story is changing very fast.