Bank of America in talks to buy Merrill Lynch

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Bank of America's $40bn-plus takeover talks with Merrill Lynch represent a sudden about-face for the retail bank's chief executive, Ken Lewis, who said last year that he had already had "all the fun I can stand in investment banking".

But Mr Lewis's change of mind seems of a piece with an extraordinary weekend of upsets that will reshape Wall Street forever.

Facing a meltdown in its share price, as investors hunted for the next victim of the credit crisis after Lehman Brothers, Merrill Lynch's chief executive, John Thain, propose a radical solution on Saturday to protect what value he could for shareholders.

The takeover would hand North Carolina's Bank of America would something it has always coveted but never quite managed to achieve through organic growth: a place in the big league of investment banking. Reports last night suggested the combined investment banking operations would come under the control of Merrill Lynch president Greg Fleming, with its risk management and trading operations being combined under Thomas Montag, a former Goldman Sachs executive who started at Merrill in August.

It seemed unlikely that there would be a role for Mr Thain, who took the top job at Merrill Lynch at the end of last year, after the ouster of Stan O'Neal, whose ill-fated foray into the mortgage derivatives business put one of the oldest franchises on Wall Street in peril.

Mr Thain has tried to right the ship, but the company has lost more than $40bn (£22bn) since the start of the credit crisis, and in July it shocked Wall Street with plans to raise $8.5bn in new shares, after the chief executive had said it was well capitalised to survive the credit crisis. On Friday, as Lehman tottered, Merrill shares slid to new lows.

Bank of America walked away from talks with Lehman Brothers on Saturday, unable to satisfy itself a takeover was a good idea unless there were guarantees from the Federal Reserve to backstop Lehman's trading positions. Barclays also dramatically walked out of talks to rescue Lehman Brothers yesterday afternoon, leaving the 158-year-old firm on the edge of bankruptcy.

In a game of extraordinary brinksmanship, the Fed – which had agreed to extend a $30bn loan to help the emergency takeover of Bear Stearns by JPMorgan Chase in March – insisted that Wall Street must finance a solution by itself this time.

Given the seriousness of the situation, the New York Fed first called in all of Wall Street's top chief executives on Friday night to plan a rescue. Fuelled by fruit and sandwiches, they continued to work through the weekend.

Bob Diamond, the chief executive of Barclays Capital, the UK bank's US-based investment banking division, was among those seen entering the New York Fed building in Manhattan's financial district over the weekend. Although Mr Diamond is keen to expand Barclays Capital, the speed with which a Lehman deal would have to be agreed worked against him. Barclays feared the UK regulator, the Financial Services Authority, and shareholders might balk at its absorbing Lehman, particularly since Barclays' own capital position has been of concern. The deal structures discussed yesterday would require a shareholder vote, which would mean setting out the exact liabilities the company was taking on. Without federal assistance, Barclays would be asking shareholders to sign a blank cheque.

As talks went into the late afternoon, the mood darkened. Options on the table had included separating $85bn in risky assets – such as mortgage derivatives and commercial real estate – into a stand-alone company propped up by contributions from up to 15 Wall Street firms. But some chief executives said their banks' balance sheets were already too stretched for them to contribute.

Meanwhile, Lehman hired lawyers to work on a nuclear option of filing for bankruptcy, a move that would have unpredictable consequences in today's interconnected global markets.

The final hours

*6pm Friday

The Federal Reserve Bank of New York summons 30 Wall Street chief executives to its fortress-like headquarters in downtown Manhattan. Hank Paulson, the US Treasury Secretary, pictured right, and Tim Geithner, the head of the New York Fed, tell them that there is no taxpayer money on the table, so they had better hash out a deal among themselves.

*6pm Saturday

A parade of black limousines lines up outside the Fed to take those executives that remain away, with no deal in sight. Discussions at the Fed and at Lehman's midtown Manhattan headquarters, had centred on a plan to separate the bank's "bad" assets – commercial and residential mortgages in the main – from the rest of the bank, which Bank of America and Barclays were interested in buying. Both suitors, though, were still pressing for federal money to cover Lehman's trading liabilities.

2pm Sunday

Derivatives traders on Wall Street are called to their desks for an extraordinary shadow trading session to reduce their exposure to Lehman in the event of its failure. The aim is to see which positions can be cancelled or netted off against each other. The trades would "go live" at midnight if there was a bankruptcy filing by Lehman, an option that appeared to become more likely as Bank of America was said to have cooled on a deal.

*4pm Sunday

News breaks that Barclays is also walking out of talks, citing the Fed's refusal to provide financial guarantees for a deal. That appeared to make Lehman's bankruptcy inevitable, unless either side changed their positions.

*5pm Sunday

Attention turns suddenly to Merrill Lynch, regarded as the next weakest of the independent investment banks after Lehman, and a prime candidate for a share price collapse when trading resumes this morning. Insiders say that Bank of America is in advanced talks about acquiring the company, with the aim of doing a deal by midnight, US time.