Lehman talks set to resume on Sunday

By Dan Wilchins and Glenn Somerville

NEW YORK/WASHINGTON (Reuters) - Bankers and regulators held a second day of emergency talks to tackle the crisis at investment bank Lehman Brothers and soothe financial markets after U.S. Treasury and Fed officials urged Wall Street chiefs to come up with their own solution.

So far this year, the government has sponsored rescues of Lehman rival Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae .

But this time, U.S. Treasury Secretary Henry Paulson is adamant that federal funds not be used for a bailout, a source familiar with his thinking said on Friday.

The talks on Saturday ended without an announcement, but the final outcome could include hiving off Lehman's bad assets into a "bad bank", in which rival banks would acquire stakes, or even allowing it to file for bankruptcy, people briefed on the matter told Reuters earlier.

It's a fine balancing act for Paulson and the Federal Reserve.

They don't want to be accused of encouraging excessive risk-taking by bailing out another yet another investment bank. But they also cannot afford to let a blow-up of Lehman paralyze the financial system and deepen the credit crisis.

Lehman Chief Executive Dick Fuld has looked at selling the entire company to banks including Bank of America Corp, the No. 2 U.S. bank by assets, and Britain's Barclays, a person briefed in the matter said.

The banks are reluctant to buy the 158-year-old firm without government backing similar to that received by JPMorgan when it took over Bear Stearns in March, media reports said.