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Lehman Brothers will file for Chapter 11 bankruptcy protection. The filing will be by the holding company and won't include any of its subsidiaries, Lehman said. The US investment bank has 100 employees in Australia and 26,000 worldwide.

As Lehman collapses, senior US Treasury officials, Wall Street banking bosses and the Federal Reserve are pulling out all stops to avert a collapse of the global banking system.

A measure of this desperation is the announcement from the Fed issued a short time ago that it will allow Wall Street banks to swap their unsaleable "mortgage backed securities'' for Treasury bonds.

As it was the Fed's appeasement of Wall Street and the reckless speculation and product-pumping of the Street's investment banks which landed markets in this predicament in the first place, the recriminations will be endless.

To more pressing matters though - if the US authorities don't restore confidence by the time share markets open tonight a crash is not out of the question. It has become clear over the past 24 hours that the credit crisis is a lot worse than people suspected.

The situation is fluid and hard to call but it seems Bank of America is likely to take out Merrill Lynch, Lehman Brothers will be allowed to fall, Blackstone may manage the work-out of Merrill's and Lehman's debt and real estate positions, and other bank mergers are also likely to occur. A merger of Morgan Stanley and Wachovia is one possible outcome.

Speculation of Bank of America bidding for Merrill Lynch is evidence enough of the trouble Wall Street is in. That this proud 94-year old brokerage labelled "The Thundering Herd'' is meekly capitulating to an offer from a retail bank can only suggest that it did not have much choice.

In what must be a hothouse atmosphere of fear, threats and pressure-tactics in the New York meetings throughout Sunday, the Fed has been pushing the investment banks to set up a $US70 billion rescue package to rescue their own.

Further and this is a fairly concrete sign of desperation - the Fed is effectively flooding the market with cash in a bid to restore confidence.

In its release this morning it says it will accept "all investment grade securities'', which presumably means anything rated above BBB. There is a lot of junk in that range.

As Standard & Poor's, Moody's and the other agencies would - according to an email which turned up in the SEC review of ratings agencies - "rate a cow if you paid us'', there will be some pretty dodgy assets swapped into the Fed for cash.

"The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged," said the Fed release.

"These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.''

Things are moving quickly. A measure of the mayhem is a Bloomberg story filed at 22.28pm New York time saying, "The Fed will now accept equities in the Primary Dealer Credit Facility, its program for lending cash directly to securities firms, in addition to investment-grade debt.

We couldn't find mention of the Fed buying "equities'' in its latest missive. If true, that's even more desperate. The news about lowering the bar on debt securities is worrying enough.

In an emergency measure to prop up Wall Street at the time of the Bear Stearns collapse in March the Fed had allowed banks to swap their high-rated securities for treasuries.

Today's announcement opens the gates right up. It also comes hard on the heels of the biggest nationalisation in US history - the bail-out of mortgage giants Fannie Mae and Freddie Mac just a few days ago.

The Fed has also increased the size (from $US175 billion to $US200 billion) and the frequency of its treasuries auctions.

The great unknown for Wall Street remains what will the knock-on effect of a liquidation of Lehman Brothers. Lehman has until midnight tonight to find a white knight or some manner of rescue package.

Once it goes into liquidation few will be able to predict the counterparty risks which would reverberate through financial markets. Few would have a handle on the likes of Lehman's credit default swap and other derivatives risks.

The consequences will be global. Via its acquisition of Grange Securities two years ago, Lehman inherited a local client list worth $2 billion. This client list, revealed in Business Day last month, spanned dozens of local council, semi-government, charity, church and super fund clients which had acquired CDOs (collateralised debt obligations) and other fancy debt instruments from Grange.