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No Bailout: Feds Made New Policy Clear in One Dramatic Weekend

Global stocks have experienced wild fluctuations this week in the wake of the U.S. government's seizure of insurance giant American International Group, the failure of Lehman Brothers, the disappearance of Merrill Lynch as an independent company and reports the U.S. government will set up a government entity to take on bad debts from financial institutions.

Geithner was more restrained, but his presentation no less dramatic. He revealed that the Fed had been drawing up contingency plans for a Lehman bankruptcy and was prepared to use them if no private-sector deal could be struck.

The opening statements, combined with news reports that the government was drawing the line at a bailout, meant the government couldn't change tacks later without undermining its credibility in any future negotiations.

The executives shared their views on a wide range of subjects. Several asked Paulson and Geithner whether there would be a broader government effort to address unfolding problems at Merrill Lynch, Washington Mutual and American International Group, among others, once Lehman's situation was resolved.

Paulson and Geithner stressed there would be no government money to help any firm that ran into trouble next.

Before 9 p.m., Paulson and Geithner asked the executives to go back to their firms and analyze the situation with their best people. Banks that had examined Lehman's assets were to share their findings with the rest of the group by the next morning.

The officials also laid out plans for the weekend. Some firms would delineate a scenario in which Lehman's healthy assets would be sold to a suitor and the bad assets would be spun off to a separate enterprise, which would receive new funding from a consortium of Wall Street banks. Most of the participants hoped for this outcome because it would prevent Lehman's assets from becoming devalued, which could trigger losses at other firms that hold similar assets.

A separate group would work on predicting what would happen if no one bought Lehman and the firm was forced to file for bankruptcy.

While conversations between the executives continued, Paulson and Geithner left the meeting and took the elevators to Geithner's office on the 13th floor. An office suite was set up for Treasury officials, including Chief of Staff Jim Wilkinson, as well as Dan Jester and Steve Shafran, both senior advisers who have worked at the investment bank Goldman Sachs. Separate rooms were given to the SEC staff.

Though many of the government officials concluded a deal was unlikely, Paulson was optimistic that a private solution would emerge for Lehman and possibly even Merrill or AIG.

On Saturday, the scene turned chaotic as hundreds of bankers flowed in and out of the vault-like New York Fed building, which is nestled between the narrow streets of Lower Manhattan. Right outside the conference room on the first floor, a spread of coffee, bagels and doughnuts was set up. The media tried to get photos and names of everyone who entered the building.

The morning also brought dark clouds. Some of the banking analysts revealed that Lehman's assets were of far worse quality than had previously been thought. It might be hard to find a firm to buy them.

Two possible suitors included Bank of America and Barclays, which had told Treasury of their interest in phone conversations before the weekend. But both companies said they wanted federal guarantees.

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