roy043,
The simplification you propose certainly works, but means as you said
that it takes place outside the lambda.
The generic form of what they call the Y function or Y-combinator
from the paper by Don Blaheta is:
(lambda (f) ((lambda (x) (x x)) (lambda (x) (f (x x)))))
Works by recreating a lambda at every step of the recursion.
I am not too sure it is very useful though, but mind boggling nonetheless.
ymg