Global markets dive after Lehman declares bankruptcy

Global stock markets plunged this morning after it emerged that Lehman Brothers, the 158-year old bank, had filed for bankruptcy after a weekend of rescue talks masterminded by the US Government failed.

In London, the FTSE 100 index of leading blue chip companies fell by 154.2 points to 5,262.5 in early trading, reversing gains made at the end of last week when a chance to secure Lehman's future remained.

In France, the CAC 40 index of leading shares lost 2.48 per cent, while Frankfurt’s DAX fell 1.55 per cent to 6,138.42 points.

Bank shares were predictably badly hit. Morgan Stanley was down almost 10 per cent in Frankfurt, while reports that the world's biggest insurer, American International Group, was seeking rescue funding meant its shares lost a third of their value on the German market.

In contrast, Merrill Lynch shares were up 38 per cent after it struck a $44 billion (£24.4 billion) deal to sell the group to Bank of America.

While the Merrill deal is expected to be widely perceived as a positive move, the collapse of Lehman, which controls $600 billion worth of assets, has sent shock waves through the London and New York stock and debt markets.

It is widely expected that the Dow Jones industrial average will open 300 points lower when trading begins.

Lehman Brothers said today that its customers would be able to continue to use their accounts normally and it will take a series of actions today that should allow it to continue managing its operations, including paying staff wages.

Lehman Brothers said: "The board of directors ... authorised the filing of the Chapter 11 petition in order to protect its assets and maximise value".

Traders from all the big banks were ordered back to their desks on Sunday afternoon to calculate their exposure to a possible collapse of Lehman Brothers.

While the bank has widely been perceived as most vulnerable because of its substantial holdings of mortgage-backed secuities, it was the US Treasury's refusal to bankroll a rescue that is regarded as preventing other parties from bailing out the bank.

US authorities had tried to secure a rescue deal for Lehman Brothers over the weekend.

Mr Paulson and Tim Geithner, president of the New York Federal Reserve Bank, had convened an emergency meeting in New York on Friday evening to try to convince other banks to bail out Lehman.

At the same time, the Merrill Lynch board, led by John Thain, agreed to be bought by Bank of America, the mortgage provider for around $29 a share, above the $17.05 that Merrill Lynch stock closed at on Friday evening but well below the $97 they fetched in January 2007. It is understood that both boards have approved the all-share deal.

The takeover will mean that Merrill Lynch, which has been dogged by questions over the extent of its mortgage-backed securities, protected by Bank of America's substantial current account, credit card and lending businesses.

American authorities had hoped to ringfence $85 billion worth of Lehman's real estate assets into one company, which they wanted banks, such as Citigroup and JPMorgan Chase, to prop up with $35 billion of new capital.

Mr Paulson had hoped to persuade the banks to inject new money to prevent a fire sale of Lehman's assets, a move which could have triggered a fall in the value of their own securities.

At the same time, Mr Paulson had tried to sell Lehman's investment bank to either Bank of America or Barclays. However, both walked away at the weekend after Mr Paulson refused to bankroll a possible bailout of Lehman with taxpayers' funds.

On Sunday evening, Lehman Brothers, whose shares have fallen about 94 per cent over the year, was left in a vulnerable position.

During the weekend, Lehman hired bankruptcy specialists in the event that all other funding routes failed.

The Federal Reserve is now expected to try to help banks exposed to Lehman to use a wider range of collateral to borrow funds from the central bank.

In addition, 10 leading banks said they would pool $70 billion of their money to create a borrowing facility. The institutions, which include Citigroup, Credit Suisse and Deutsche Bank, could tap the pool to help them ride out the crisis.

At Lehman's New York Heaquarters In midtown Manhattan, employees were seen removing their belongings from the building ahead of the bank's expected collapse of the bank.

Christine Seib, Suzy Jagger in New York