New York - Lehman Brothers Holdings Inc, the 158-year-old investment bank, has become the largest institution to fail in US history after a last-minute rescue fell apart over the weekend.

A legendary US institution, Lehman employs about 25,000 people and reported debts of more than 600 billion dollars as it filed for bankruptcy Monday in a Manhattan court.

Apart from its debts, Lehman was valued at about 637 billion dollars in its bankruptcy filing. Its share price plunged 95 per cent.

The news sent shockwaves through the US financial sector amid fears that more banks could follow suit as the credit crisis deepens. Financial firms across the sector have battled to raise capital to keep operations going.

Lehman, the country's fourth-largest investment bank, had been in emergency rescue talks with Bank of America Corp and British bank Barclays Plc over the weekend. The US government had been heavily involved in the search for a buyer, but refused to offer taxpayer funds for the sale.

Treasury Secretary Henry Paulson defended his decision not to bail out Lehman, saying the situation was "very different" from March, when the US Federal Reserve bankrolled the sale of Bear Stearns to JPMorgan Chase.

"I never once considered that it was appropriate to put taxpayer money on the line" for Lehman, Paulson told reporters.

Bank of America plumped for Merrill Lynch & Co instead in a 50- billion-dollar takeover announced late Sunday.

Before Lehman, the largest insolvency in US history had been that of WorldCom in 2002.

Lehman played a key role in the rise of the subprime mortgage market that precipitated the outbreak of the worst financial crisis since the Great Depression.

Lehman and other firms have been taking on greater debt while offering more complicated and riskier assets to investors, without maintaining enough capital to weather any potential downturn.

As the housing boom continued through much of the decade, Lehman became the largest underwriter of mortgage-backed securities, the value of which have plummeted along with home prices since 2007.

Lehman's efforts to raise fresh capital and sell off company assets were not enough to meet its staggering debt. The firm had raised about 160 billion dollars in the second quarter.

The outlook for employees of Lehman and its international subsidiaries was unclear. Lehman has requested to maintain wages and salaries for US operations. PricewaterhouseCoopers said Lehman's 4,500 employees in Britain might not be paid this week.

German regulators halted all business operations at Lehman Brothers Bankhaus AG, which employs about 140 people.