In perhaps the most surprising development to emerge from the financial markets last weekend, Bank of America said it will purchase iconic brokerage house Merrill Lynch (MER).

The deal was brokered after BofA (BAC) walked away from a purchase of Lehman Brothers (LEH), which, after failing to find a white knight, filed for bankruptcy Monday. Each Merrill share will be exchanged for 0.8595 shares of Bank of America, which valued Merrill at $29 a share when the deal was struck, but made it less than $23 a share after BofA stock took a drubbing on Monday.

Investors didn't appear to show much confidence in the plan regardless, with Merrill shares closing below the deal value at $17.06 each. In addition, media reports circulated late Monday that a shareholder lawsuit had been filed in New York State Supreme Court against Merrill, its CEO John Thain and its board of directors, claiming the terms of the deal are unfair.

Thain sought the merger, clearly hoping to avoid the fates of Lehman and Bear Stearns, which was sold to JPMorgan Chase (JPM) in a fire sale in March.

“This is the most difficult environment I have experienced in my 33 years on Wall Street,” said Thain at a press conference Monday. “I think this combination will be strong and will do very well.”

The historic weekend is further fallout from the credit crisis that has rocked Wall Street for more than a year. Of the top five investment banks and brokerage firms operating a year ago, just three--Goldman Sachs (GS), JPMorgan and Morgan Stanley (MS)--remain independent.

Both companies’ boards of directors have unanimously approved the deal. The merger is still subject to shareholder and regulatory approval.

The deal is expected to close in the first quarter of 2009, according to the two companies.

The purchase marks BofA's second major acquisition in the past year. The bank, which was mostly untouched by the subprime mortgage meltdown, bought distressed mortgage lender Countrywide Financial for around $7 a share. 

In adding Merrill, BofA now has acquired the nation's largest brokerage house, as well as a well-regarded investment bank. Merrill's brokerage arm reaches into all 50 U.S. states.

“The fact we have the breadth of products we have now creates just an incredible combination,” BofA Chief Executive Kenneth Lewis said in a conference call with investors.

The fate of Merrill's 60,000 employees was not immediately known. When Bear Stearns was absorbed by JPMorgan, more than half of Bear Stearns's employees lost their jobs.

BofA’s Lewis said “nearly 100%” of Merrill’s brokers would be retained as part of the merger. He did not mention the fate of the firm’s investment bankers, analysts or back-office staff.

Lewis paid a healthy premium for Merrill--nearly 70% above where Merrill’s shares closed on Monday--notable in a financial environment where the value of many banks’ assets is being called into question. Merrill’s book value, or the approximate value of the firm’s entire holdings, was estimated to be around $22 a share.

Charles Whitehead, a merger and acquisitions expert at Boston University and former executive at Citigroup (C), said that despite the financial uncertainty, Merrill’s premium was worth it.

“The real value in Merrill Lynch is its brokerage business,” Whitehead said. “This is a people play, not an asset play.”

Whitehead compared Bank of America’s acquisition of Merrill with the 1997 combination of then-Citicorp and Travelers Insurance to create Citigroup. Wall Street powerbroker Sandy Weill put Citigroup together in an effort to bring every flavor of financial product to its customers in a one-stop shop.

 “Lewis can bring that cross-sale mantra to Bank of America, just like Sandy brought it to Citigroup,” he said.

Jeff Harte, a financial analyst at Sandler O’Neill, isn’t so enthusiastic.

“In this environment, we are surprised that Bank of America was willing to pay a 70% premium on Merrill Lynch,” he said.

As Lehman was slipping into bankruptcy, the general opinion on Wall Street was that Merrill’s health needed to be maintained to support the health of the broader markets.

“Merrill was worth more alive than dead to Wall Street--and Bank of America,” said Whitehead.