Financial stocks took a beating today as Lehman Brothers said it will file for bankruptcy, making it the third large US investment house to be claimed by the subprime mortgage crisis in the past seven months.
Also today, Bank of America agreed to buy US investment bank Merrill Lynch for $US50 billion as the collateral damage from the credit crisis continues to mount, sending the market into new realms of uncertainty.
"The fact that US authorities bailed out Fannie/Freddie last week, but have let Lehman fail this week, shows how the US authorities are managing two competing systemic risks," said BBY banking analyst George Gabriel.
"The first systemic risk is counter-party financial risk the risk that the collapse of a large US financial institution flows through to that institution's clients and competitors.
"The second risk is the risk of loss of confidence in the US dollar and the US economy - this could occur if too much public money is committed to bailouts.
"In short, Fannie Mae and Freddie Mac were considered too interconnected into the US economy to fail and so they were bailed out.
"This was not the case with Lehman, so no public money was committed to bailing Lehman out."
The Australian dollar zigged-zagged through the day as currency traders tried to work out the impact of the Lehman collapse.
Traders sent the dollar down as low as 81.68 US cents before it shot up as high as 82.63 US cents, only to fall again when the bankruptcy became official. The dollar last traded at 82.37 US cents.
Locally, investors and analysts reacted with alarm to Lehman's failure.
Unprecedented in 100 years
"Merrill Lynch is off the map and so is Lehman in the space of a weekend," said a banking analyst at a major investment house, who spoke on the conditions of anonymity. "It's unprecedented for the last 100 years."
"At this moment, it's hard to know the exact implications," he said.
He said one area Lehman's failure could hit local firms would be in the "massive" over-the-counter derivatives trading which affects foreign exchange, interest rates and equities markets in Australia.
The Australian Securities Exchange moved immediately to suspend Lehman from pariticpating in trade this afternoon, after the US bank signalled its intention to file for Chapter 11 bankruptcy in New York.
Lehman's failure, amid the chaos wracking the financial markets, hammered Australian banking stocks.
Financial stocks have led losses today, with the sector declining 2.7%, while the overall market was 1.4% lower, or 69.3 points, to 4834.5 in late afternoon trade. The market clawed back some of its previous losses in the afternoon after Lehman confirmed it was filing for bankruptcy, ending the speculation.
Shares in NAB lost 4.8pc, or $1.14, to close at $22.82, taking it back to May 2000 lows and bringing its year-to-date losses near 40pc.
Macquarie hit by fears
Macquarie Group, whose business has spread into areas similar to Lehman's, dropped 10.3pc, or $4.55, to $39.46, to levels not seen since November 2004.
Macquarie shares have lost nearly half their value since the beginning of the year.
Macquarie is "not as vanilla as a major bank in Australia. It's probably a bit more inventive,'' said Lisa Jarvis, financial adviser at ABN Amro Morgans.
Ms Jarvis said the market was struggling to understand how much of counter-party risk would be unleashed on to financial services companies that had done business with Lehman.
Investors would also be looking for the next major investment bank to collapse, she said, with concerns about the viability of insurer American International Group rising.
ANZ Bank lost 2.2pc, or 38 cents, to $16.87. It, along with NAB, has announced billions of dollars in write-downs tied to the fall in asset values this year.
The Commonwealth Bank shed 2.3pc, or $1.01, to $41.98, while Westpac lost 1.5%, or 37 cents, to $23.15.
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