A high-level meeting between top Wall Street executives, US Federal Reserve and Treasury Department officials Friday night was, at least in part, an attempt to prepare Wall Street for the possibility that a Lehman Brothers deal might not get done this weekend, CNBC has learned.
The meeting at the New York Federal Reserve, which included Treasury Secretary Hank Paulson, New York Fed President Tim Geithner and Securities and Exchange Commission Chairman Christopher Cox, was not said to be an indication either way that talks to sell Lehman were faltering. But officials believed it was better to have discussions about the possibility earlier in the weekend rather than later in case markets opened Monday without resolution to the Lehman issue.
On Saturday, Barack Obama's economic advisor Jason Furman told reporters on a conference call that the presidential nominee wants a "private solution" for Lehman.
"Sen. Obama believes we should have a private solution to Lehman's problem," Furman said on the call. "And, unlike Bear Stearns, the Federal Reserve now has a special lending facility in place that could prevent a wider run on the market."
In the Friday night meeting, Treasury made clear that government funds would not be made available to resolve the situation.
Also attending the meeting was John Thain from Merrill Lynch and John Mack from Morgan Stanley , among others.
The meeting was separate from ongoing talks between Lehman Brothers and potential acquirers.
A Treasury official confirmed that Paulson's position that governent funds not be used remained unchanged.
Lehman Latest Domino
On Friday afternoon, Lehman Brothers was stacking up as just the latest domino in the line of failed financials that has investors treating the entire sector as poison.
Money evaporated across the board in the sector Friday, particularly among the investment bankers and insurance titan American International Group , and the prevailing sentiment on Wall Street was that until the housing market recovers and banks can get their legs back under them, the best thing to do is to stay away.
"Nobody wants to take any chances right now," says Quincy Krosby, chief investment strategist at The Hartford. "It's basically guilty until proven innocent."
That represents a change in sentiment from investors who were looking at least to cherry-pick stocks in a sector that many considered undervalued and oversold. The big names that often provided cover in previous market downturns now are being treated as pariahs.
"I would have to say right now they're toxic," says Michael Kresh, president of M.D. Kresh Financial Services. "These companies are going to have to come around and prove beyond a reasonable doubt that they've gotten past their problems before anybody looks at them with anything but a jaundiced eye."
The group was mostly lower Friday, with Washington Mutual as an unlikely bright spot after the company issued statements saying its capital position was adequate, allaying market fears that it might be the next big bank to go down.
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Speculation also swirled that JPMorgan Chase might buy WaMu, though CNBC has learned that there is no such plan right now.
But shares at Merrill Lynch tumbled amid defensive positions among options traders and a sentiment that while the company will still be standing after the credit crunch has passed, it faces difficult times ahead.
Some veterans were bemoaning the climate of fear pervasive on the trading floor.
"Already they're looking for the next rumor-monger victim behind Lehman," Art Cashin, director of floor operations at UBS, told CNBC.
PIMCO's El-Erian expresses his feelings about financials in the accompanying video.
"People aren't willing to take the risk right now," says Jordan Kimmel, a hudge fund manager with Magnet Investing. "They're waiting for the knife not just to stop falling, but to bounce a couple times on the ground before they're willing to get back in."
"People continue to say nothing can get good until the financials get good. I don't subscribe to that. I think there's a lot going on outside the financials," Kimmel adds. "I myself am not buying any financials, nor can I figure out who is healthy at this point."
Bear-Like Bailout in the Wings?
As Wall Street wondered what would happen to Lehman , part of the speculation was that the government might step in to back up a takeover deal, the way it did when JPMorgan Chase swooped in to take over Bear Stearns in March.
Treasury sources speaking to CNBC doused such speculation almost as quickly as it arose. Still, there was concern, much the same as around the time Bear collapsed, that if Lehman fails it would be catrastrophic for the rest of the market, a phenomenon known as systemic risk that was causing the bulk of the concern.
That sentiment alone seemed to be driving trading and was the primary cause for the sector to continue to fall.
"Most investors would say as long as you're not invested in them, if they go under, they go under. That's part of the process," Krosby says. "However, there's the worry that the way that these credit derivatives work and how they spread their tentacles in terms of counterparty risk that it may not be possible to let these things go under, because you worry about the domino effect on an already-vulnerable market."
The best option, and one gaining considerable traction as Friday trading progressed, was that the weekend would see someone come in to buy Lehman, either one group to buy everything or separate entities to carve up the company into digestible parts.
"What you have is a waiting game going on," Krosby says. "Something's gotta give in a game like that. The options right now don't look very attractive, unless buyers come in. That's the key."
Invest? Yes, Just Not in Financials
Amid the current climate, until the sector gets some clarity, the popular strategy is to financial positions into any rallies that come along.
"People need to pick the rallies to lighten up," says Larry Levin, a futures trader at the Chicago Mercantile Exchange and president of commodities educational firm Secrets of Trading. "As far as I'm concerned I think the market has a much better chance of setting new lows from where we were in July, and new highs are just ridiculous at this point."
As for a recovery in financials, most advisers are taking their cues from the housing market, which continues to fight for a bottom.
"The only way this gets improved, the only way this gets resolved, is when we get to the point where the housing market starts to turn around ... and the emotional pressure is taken off the market," says Kresh, who sees money going into areas that are "bullet proof."
"Money still must be moved into the market. The question is where," he adds. "Certainly financials are not going to get their share of money until they can prove themselves as an investment that is not toxic--no long, upside potential, we're just worried about total toxicity."
In the meantime, money on the sidelines continues to look for places to go even as perhaps the market's key sector continues to struggle.
"This has got to be one of the toughest times in anybody's experience in the market," Kimmel says. "When you have that gut feeling, when you can't sleep at night, when you feel like giving up, we all know that with the cash on the sidelines that usually presents opportunity. Find a name whose revenue and margins are growing in this environment. They're out there, they're really out there."