

This is the day of reckoning for Wall Street. The bankruptcy of

Lehman Brothers, the sale of Merrill Lynch, and the troubles at

American International Group have combined to send huge shock waves throughout the financial world.

Who could be next and when does the credit storm ease up? How does Washington deal with the fallout?

Here is where we stand:

The Fallout:

Stocks fell sharply around the world, with the benchmark Dow Jones industrial average in the U.S. tumbling more than 300 points, or more than 2.5 percent, before rebounding slightly. London fell as much as 5

percent and Frankfurt as much as 4 percent before recovering somewhat;

European indexes generally were down 3 to 4 percent as floor trading ended. Bank stocks are among the biggest losers. The major Asian markets—Tokyo, Hong Kong, and Shanghai—were closed for a holiday today.

Australia closed down 1.8 percent, while Singapore fell 3.3 percent.

Credit default swaps also soared across the board. Even financially sound companies like General Electric were hit by investors suddenly skittish about everyone's creditworthiness. G.E.'s finance unit, GE Capital, saw its swaps jump by more than half today, to 348 basis points from 209

basis points on Friday. That means the cost to protect $10 million of

GE Capital's debt rose to $348,000 a year today from $205,000 last week.

The Unwinding: The parent company, Lehman Brothers Holdings, filed

for Chapter 11 bankruptcy protection in U.S. bankruptcy court in

Manhattan. None of its broker-dealer subsidiaries are included in the filing, and they are continuing to operate. Lehman's bankruptcy is the biggest by a financial institution since Drexel Burnham Lambert, the firm whose fortunes rose and crashed with the junk-bond market, filed for Chapter 11 in 1990. Like Drexel, Lehman is expected to ultimately go into a runoff as it unwinds its trades.

Whether an unwinding can be orderly in the current environment is the $1 trillion question.

On Sunday, the International Swaps and Derivatives Association, a trade group, organized an extraordinary ad hoc Sunday trading session. The goal was to give financial institutions a chance to offset their exposure to credit derivatives tied to the weakest of the stricken banks, Lehman Brothers.

But analysts say that the liquidation of Lehman will put the financial markets under pressure for some time as banks are forced to take additional write-downs and credit spreads widen. And the *Wall Street Journal *reports that some traders are having trouble trying to find new counterparties for their trades with Lehman.

The Next Victim:

The financial firm seen as the most vulnerable is now clearly the

American International Group. The insurance giant, desperate for new capital as its losses mount, may announce asset sales as soon as today.

The company has also reportedly asked the Federal Reserve for $40

billion in short-term financing.

A.I.G. lost more than $13

billion in the first half of this year, most of it due to investments in mortgaged-backed securities and other debt-related instruments.

And there may be others. Still overhanging the financial-services industry is the fate of Washington Mutual, one of the nation's largest mortgage lenders. A team of private equity firms pumped $7 billion into the thrift last April, but its losses have continued to mount and its shares barely paused in their slide. They have lost more than 90

percent of their value in the last year, and closed on Friday at just over $2.

The End of the Investment Bank: With Bank of America's $44 billion acquisition

of Merrill Lynch, only two independent Wall Street firms remain:

Goldman Sachs and Morgan Stanley. Will they now feel pressure to merge with a big commercial bank?

When it was clear that there would be no rescue deal for Lehman, Merrill Lynch chose to welcome a suitor before its own situation was untenable.

With the deal,

Bank of America leaps over Citigroup to become a behemoth in every niche of finance, from credit cards to derivatives. Is the financial supermarket back?