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AMERICAN FINANCE HAS BEEN RESHAPED not by design but crisis.

Just a week after the Treasury effectively nationalized Fannie Mae (ticker: FNM) and Freddie Mac (FRE), virtually all U.S. financial institutions are being placed under government protection -- and eventually regulation -- most likely by the Federal Reserve.

In a virtual flash, two of Wall Street's most storied names -- Merrill Lynch (MER) and Lehman Brothers (LEH) -- are likely to disappear, following the likes of Salomon Brothers, Kidder Peabody and, most recently, Bear Stearns.

The Fed, for its part, has further expanded its role as the backstop of the nation's, and indeed the world's financial system, by yet again liberalizing the collateral it will accept for loans. Meanwhile, the Fed also implicitly drew a line that it would no longer provide a direct bailout of the likes given to underwrite the rescue of Bear Stearns by JPMorgan Chase (JPM), leading to a likely bankruptcy filing for Lehman.

Meanwhile, banks such as Bank of America (BAC) and JPMorgan Chase appear to be the new paradigm, combining commercial and investment banking under one roof. With the reported acquisition of Merrill by BofA, there will be an American financial colossus along with lines of Deutsche Bank or Credit Suisse, even more than the combination of JPMorgan with Bear.

Indeed, this new model essentially vindicates the vision -- if not the execution -- of Citigroup (C) as assembled by Sandy Weill. And it calls into question if the remaining healthy Wall Street majors -- Goldman Sachs (GS) and Morgan Stanley -- will be able to overcome the competitive disadvantage of not having a banking network to support it.

Further, recalling Wall Street's lifeline to Long-Term Capital Markets in 1998, a consortium of banks established a $70 billion fund to provide liquidity to distressed borrowers. Indeed, the plan recalls when J. P. Morgan, the man whose name the bank bears, forced the major bankers of the day to come up with a plan to halt the panic of 1907.

The senior Morgan would well recognize the structure of the financial world that may emerge, in which commercial banks will likely form the basis of major financial institutions. Banks offer a stable source of funds in their vast supply of deposits from millions of customers. That will be vital as institutions take assets back onto their balance sheets.

Out goes the model of "originate and distribute," in which loans would be made, then sold to Wall Street, which sliced and diced them in indecipherable ways, and then sold them as securities, with each getting a cut along the way and none having a particular stake in the soundness of the asset.

There is likely to be at least a partial return to the old-fashioned notion of a bank making a loan and retaining at least some part on its balance sheet so it has some stake in its ultimate repayment.

To fund the originate-and-distribute business, only a sliver of capital was needed. The wholesale money markets provided the working capital -- the money in the till the company needs for its operations. That money was readily available at low cost, and cheap money makes all sorts of dodgy operations work.

That's no longer available from the interbank, repurchase agreement and commercial paper markets. As a result, banks -- including the Wall Street variety -- find that the stable base of deposits -- with the backing of the Federal Deposit Insurance Corp. -- are a preferable base on which to build a business. That's especially the case with the move toward "re-intermediation," which in essence means putting loans back on banks' balance sheet instead of selling them off for a fee.

But the elder Morgan would scarcely recognize a central bank acting as lender of last resort for the entire financial sector, banks, investment firms, and possibly insurance companies. At this writing, American Investment Group (AIG) reportedly was seeking a loan from the Fed after talks for a capital infusion broke down.

Morgan would, however, recognize the winner-take-all financial structure that emerged in recent years as Wall Street firms and privateers such as hedge funds could make hundreds of billions largely by the use of leverage.

Yet, the prospect of the failure of one such aggressive player, Lehman, looks to shake the world's markets. But it does not seem to pose the risk of a global meltdown, as seemed possible when Bear Stearns was about to fail last March. That might have been the Hurricane Katrina for the markets, had the Fed not stepped in. Lehman may be more like the recent Hurricane Gustave, in which government agencies prepared for the worst and, thankfully, avoided that.

The worst would have been the impact of a Bear bankruptcy on the derivatives market, where it was a counterparty to billions of dollars' worth of contracts, along with JPMorgan, its eventual acquirer. Over the past weekend, Wall Street reportedly was working feverishly to match firms' exposure to Lehman; typically, they would have bought and sold billions of contracts with the firm, and they sought to match up purchases and sales to reduce their net exposure.

Nevertheless, there are certain to be significant stresses in the credit and derivative markets as participants work out their exposure to both Lehman and AIG, both major players in those sectors.

Asian markets are down sharply in early Monday trading while U.S. Treasury yields are also markedly lower. But the moves, though relatively large, are not out of line of what's been seen recently. In other words, more of the same, at least so far.

"Give me a lever long enough, and a prop strong enough, I can single-handed move the world," Archimedes said.

Wall Street found it could construct a lever nearly infinitely long. But it ultimately lacked a prop -- that is, capital -- sufficiently strong. As a result, it finds itself turning to the government and the Fed to support it. Regulators are providing a prop, and preventing a collapse. But that will mean a far different world, and one less easily moved by leverage or those who manipulate it.

Comments: randall.forsyth@barrons.com