September 11 will always be a dark day in New York and particularly on Wall Street. Seven years ago Lehman Brothers’ offices were destroyed by the attacks on the World Trade Center, and one staff member lost his life.

This year Lehman’s bankers had other worries on this grim day of remembrance. The 158-year-old investment bank was teetering on the edge of collapse, brought down in large part, so insiders argue, by rumour and speculation that have driven Lehman’s share price into the gutter.

As Lehman’s combative boss Richard Fuld fought to keep his firm going last week, employees were engaged in a cyberwar scotching internet rumours that they had already gone bust. On Wikipedia, the online encyclopedia anyone can edit, one false clairvoyant wrote that the company had gone into liquidation on Friday after pleading with regulators for a delay.

Another mischievous Lehman-watcher posted an online ad on Craigslist, the classifieds website: “Free! Bulge Bracket Investment Bank (Midtown West). Run your own 158-year-old bulge bracket investment bank located in Midtown Manhattan with satellite offices in major global financial centers. All serious enquiries will be considered regardless of source of funding, nationality or antitrust considerations.”

Someone at Lehman had both postings swiftly deleted. If only the rest of the bank’s problems could be dealt with so easily. By Friday the bank was in so much trouble that the Federal Reserve Bank of New York called in all the heads of the “bulge bracket” (big) investment banks to discuss Lehman’s future.

At the 6pm meeting in downtown Manhattan, Hank Paulson, the Treasury secretary, and Tim Geithner, the New York Fed chairman, made it clear this was an industry problem that the government was not keen to bail out. Wall Street would have to find a solution.

With the financial system in turmoil, the American taxpayer was already picking up the bill for the biggest bailout in history, propping up mortgage giants Fannie Mae and Freddie Mac. In March the Treasury had bailed out Bear Stearns, the investment bank. Paulson faced charges of going too far if he threw taxpayers’ money at Lehman too.

Paulson will face tough questions about Fannie and Freddie when he appears before the Senate banking committee on Tuesday. Richard Shelby, the committee’s chairman, has made it plain that he opposes a rescue of Lehman. “They are not too big to fail,” he said. “I don’t see this as a national problem. I see this as their problem.”

This weekend, Lehman’s head is on the block as meetings over its future continue. Will Paulson go to Washington on Tuesday having successfully whipped the banking industry into resolving this crisis? Will he have blinked and put government money in after all? Or will Lehman have simply collapsed, with untold knock-on effects to the banking system? Paulson has been so active on Wall Street recently that “Breakfast at Hank’s” has become bankers’ shorthand for a crisis meeting. In Lehman Brothers, he has a problem that cannot easily be resolved over muffins and coffee.

Toxic property assets have cost the bank $6.7 billion (£3.7 billion) in the past two fiscal quarters. So far this year the shares have lost more than $60 and closed on Friday at $3.75.

Fuld, who is both chairman and chief executive after nearly four decades at the bank, has made several attempts to reassure staff and investors that Lehman is a going concern. Critics charge he has been too slow to recognise the scale of Lehman’s problems and too quick to blame outsiders for causing them. Earlier this year Fuld told top managing directors: “I’ll tear the arms off all these short sellers. And I promise I’ll get back the $70 [a share] for you.”

On Wednesday, Fuld reported a $3.9 billion loss for the third quarter, worse than expected, and set out a rescue plan that involved selling Neuberger Berman, its prized investment-management division, and splitting Lehman into a “good” bank and a “bad” bank to isolate dodgy bets.

This plan, which could take months to complete, failed to impress. “They have days not months,” said one Wall Street analyst.

Inside Lehman the criticisms were equally fierce. Staff – in New York, London and around the world – have been hit hard by the bank’s collapse, and their holdings in the company have plummeted more than $10 billion. Fuld’s holdings alone are down about $650m since January.

Even the staunchest supporters of his regime are beginning to reveal their frustrations.

“We’re out there trying to persuade big companies that they should take advice from us on how to do deals,” said one senior source at the firm. “It’s hard to be taken seriously in that regard when there are legitimate questions being asked about the decisions taken by our own management. This should never have been allowed to happen.”

With his survival plan in tatters, Fuld began talking late last week to potential suitors. A consortium of Bank of America, JC Flowers and China Investment Co, the Chinese sovereign-wealth fund, were looking at a bid. Barclays, HSBC and Nomura were also seen as potential buyers. But – after the precedent set by the Bear Stearns, Fannie Mae and Freddie Mac deals – all were looking for a government sweetener.

Sources close to Bank of America have argued that it would be difficult to complete a takeover of Lehman without some form of support from the authorities. Barclays is thought to be adopting a similar stance.

Friday evening’s meeting – let’s call it Cocktails with Hank – was Paulson’s way of getting the message out that he would not play their game.

Paulson and Geithner, backed by Christopher Cox, head of the Securities and Exchange Commission, addressed Wall Street’s Alist of bankers: Lloyd Blankfein of the Goldman Sachs Group, James Dimon of JP Morgan Chase, John Mack of Morgan Stanley, Vikram Pandit of Citigroup and John Thain of Merrill Lynch. Executives from Royal Bank of Scotland and the Bank of New York Mellon were also present. Lehman was noticeably absent.

It has been a decade since such a high-powered emergency meeting was convened. In 1998 Wall Street’s banks, with the exception of Bear, rode to the rescue of Long Term Capital Management (LTCM), a huge US hedge fund. The bankers put up $3.65 billion to save LTCM and began an orderly wind-down of the fund, averting what might have been big losses across the financial system.

Government officials are arguing that, unlike the LTCM and Bear Stearns crises, the markets have had time to adjust to Lehman’s potential collapse. But given the firm’s size and its complex deals with trading partners around the globe – it is unclear how much it owes to other banks, and even to which banks – its collapse would inevitably drag down an already battered market.

Bankers said yesterday that a quick resolution was far from certain. “This isn’t an easy deal to do. Due diligence needs to be done and pricing the loan portfolio is very difficult. Nobody trusts anyone these days,” said one banker.

Bankers warn that, if no agreement is reached this weekend, Moody’s is set to downgrade Lehman’s credit rating, triggering a complete collapse in the already battered share price.

Paulson may be stuck in a game of chicken with potential buyers who simply do not believe his tough talk. It’s a buyer’s market and, if the government wants a deal done it may be forced to offer some costly guarantees.

At what price, though? The giant bailout at Freddie and Fannie has added $5.4 trillion in potential liabilities to the government balance sheet. And more crises seem to be coming down the line.

“There is a domino effect that Paulson is very worried about, which is beginning to scare people across the industry,” said one senior banker in London.

“If Lehman gets solved this weekend, then the talk will just move back on to someone else. They can’t bail out everyone.”

AIG, the world’s largest insurer, is one giant under severe pressure. Its shares have slumped to 20-year lows, plunging 46% last week, and it is in danger of a credit downgrade.

The firm, which sponsors Manchester United’s shirts, has slumped as the cost of insuring its debt has risen and concerns have grown that the company may be the next big American financial firm to run short of cash.

Its exposure to assets scarred by the sub-prime mortgage crisis still runs to tens of billions of dollars. Over the past three quarters it has lost $18 billion on derivatives linked to sub-prime losses.

AIG is believed to be talking to Swiss Re and Munich Re about a possible sale of its 59% stake in New York-listed reinsurance group Transatlantic Holdings, which could raise about $2.4 billion. The cash would only scrape the surface of the company’s problems, however.

Robert Willumstad, who took over from British-born Martin Sullivan as AIG’s chief executive less than three months ago, has also been considering a similar plan to that proposed by Lehman, siphoning the group’s bad assets off into a new company.

On Friday, the firm appointed JP Morgan to evaluate its options and may be forced to make an announcement about sell-offs as early as this week. An AIG spokesman said: “We are working with a number of firms on a variety of options.” He said he could not comment on whether the firm would be making further announcements tomorrow.

Merrill Lynch is widely tipped as the next Wall Street bank to feel the heat if Lehman folds. It has written down more than $40 billion in bad debts over the past year. Earlier this month, Goldman Sachs analyst William Tanona predicted it would write off off another $5 billion.

Another weakened giant is Washington Mutual, America’s biggest savings and loan firm – similar to a UK building society. On Friday it projected a $4.5 billion write-down for soured loans and was downgraded to “junk” status by Moody’s.

Investment bankers believe it is only a matter of time before WaMu, as it is known, is forced into a takeover by JP Morgan or Wells Fargo.

How many others are in trouble? The Federal Deposit Insurance Corporation, America’s banking regulator, keeps a list of “problem banks” but doesn’t name them for fear of causing a run on them. In March when Bear Stearns collapsed there were 90 banks on the list; now there are 117.

“At some point you have to let one of these companies fail,” said Mike Larson, an analyst at Weiss Research. He said bailouts could lead to a situation like that experienced in Japan in the 1990s, where the economy was dragged down by “zombie” banks kept alive by government money. “Someone is going to have to pay this bill.”

Nouriel Roubini, professor of economics at the Stern School of Business and chairman of RGE Monitor, said Washington’s previously “fanatically laissez faire” attitude had precipitated this crisis and forced regulators to perform a humiliating about face to become “the United Socialist State Republic of America.” But this was “socialism for the rich” where profits were privatised but debts were picked up by the taxpayer.

Roubini said lax regulation had led to the current problems and now that the government’s coffers had been opened, officials will have a hard time closing them.

“Many of the companies not in financial services are going to say the banks are being bailed out, why shouldn’t we?” he said. The car industry is already looking for $50 billion in subsidies. The troubled airline industry may be next.

Paulson has talked of the “moral hazard” of government bailouts – a situation where companies act carelessly because they know the government will pick up the pieces. It’s a debate Roubini said American regulators should have been having years ago during the excesses of the boom years.

“In principle Lehman should be allowed to go,” said Roubini. “But if that happens the next day there will be a run on Merrill Lynch, Goldman Sachs. Let’s not pretend that’s not going to happen. The systemic risk is worse now than it was with Bear Stearns. It’s pretty pathetic really. They are running out of ideas.”

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