Officials from the Federal Reserve and the Treasury are involved in negotiations going on behind closed doors at Lehman, but sources say U.S. Treasury Secretary Henry Paulson is "adamant" that no government money be used in any Lehman deal, the way it was used in the JPMorgan purchase of Bear Stearns in
(What will happen to the market if Lehman fails? Click on the video at left.)
AIG shares plummeted 25 percent, making it the biggest drag on the Dow, as many say it's the next shoe to drop, given its exposure to the mortgage market. The world's largest insurer has half a billion invested in Fannie Mae and Freddie Mac and may need to raise additional capital. CEO Robert Willumstad is expected to unveil a turnaround plan on Sept. 25.
An anomaly in the sector, Washington Mutual shares advanced after the company issued a statement saying it has enough capital. Earlier, the stock was down more than 8 percent after Moody's downgraded it to "junk" status following the bank's announcement that it would add $4.5 billion to its loan-loss reserves.
WaMu shares have lost more than 92 percent of its value in the past 52 weeks.
Other financials were mixed as many investors are reluctant to take any chances on the sector.
Among other financials in traders' crosshairs today was Merrill Lynch, which tumbled more than 10 percent.
But stocks appeared poised to finish higher for the week, with the Dow on track for a 200-point gain.
You have to look at the big picture, Tobias Levkovich, chief U.S. equity strategist at Citi, told CNBC.
"There are different things going on in the market than there are at individual companies," Levkovich said. "The market is actually kind of looking past this," he said, referring to worries about the financial sector.
Levkovich sees the problem areas as energy, materials and industrials, with oil trading down near $100 a barrel and other economies around the world heading for a slump. He's overweight on health-care equipment and services, banks, insurance, chips and chip equipment.
Crude oil flitted below $100 a barrel before settling at $101.18 a barrel amid concerns about Hurricane Ike, which is barreling toward the Texas Gulf Coast.
For the week, oil shed about $5 a barrel.
Retail sales fell 0.3 percent, when economists had expected a 0.2-percent rise amid a drop in gasoline prices and weak consumer spending. Excluding autos, sales were off 0.7 percent, lower than the 0.2-percent drop expected.
In other economic news: Producer prices fell 0.9 percentin August, nearly double the 0.5-percent decline expected, but core prices rose 0.2 percent, as expected. Consumer sentiment hit an eight-month highin a mid-August reading, blowing past expectations, amid relief over lower gasoline prices. Business inventories increased by 1.1 percent in July, the highest in more than four years and more than double of what was expected, as auto inventories ballooned.
Monday: Empire State manufacturing survey; industrial production
Tuesday: CPI; Fed meeting; Earnings from Goldman Sachs, Best Buy, Adobe Systems
Wednesday: Weekly mortgage applications; current account; housing starts; oil inventories; Earnings from Morgan Stanley and General Mills
Thursday: Weekly jobless claims; leading indicators; Philly Fed; natural-gas inventories; Earnings from FedEx, Oracle and Palm
Friday: Quadruple witching