Bear Stearns, one of the nation's biggest and most prominent investment banks, stunned Wall Street Friday by announcing it had turned to rival JP Morgan Chase and the federal government for an emergency bailout.
The surprise, last-ditch rescue effort, announced just before the stock market opened, was the latest troubling sign of how a cascading credit crisis is threatening the liquidity of even Wall Street's most established firms.
If Bear Stearns were to go under, "it has the potential of bringing down the whole market," said Richard Bove, an analyst at Punk, Ziegel & Co. "This is the crescendo of the crisis."
Shares of Bear Stearns fell nearly 50 percent, and the Dow Jones industrial average ended with a loss of nearly 200 points. Bear Steans, which traded near $100 a share late last year, closed Friday at $30. JP Morgan Chase, the nation's No. 3 bank and one of the Dow 30, fell about 4 percent.
"Our liquidity position in the last 24 hours had significantly deteriorated," Bear Stearns Chief Executive Alan Schwartz said in a statement. "We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations."
JPMorgan Chase will provide an unspecified amount of funding to Bear Stearns for an initial period of 28 days, and those loans will be effectively insured by the Fed.
Schwartz confirmed, as many on Wall Street suspected, that Bear Stearns could now be up for sale. He told analysts during a conference call that the short-term funding "is a bridge to a more permanent solution."
Top executives from both companies were considering the outright sale of Bear Stearns to JPMorgan, according to a person familiar with the talks who was cited by The Associated Press. JPMorgan has been hurt far less by the mortgage morass than other investment banks.
In backing up JPMorgan, the Fed dusted off a rarely used, Depression-era provision to provide loans. It also said it was ready to step in to fight an erosion of confidence in the nation's largest financial institutions.
“The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system,” the central bank said in a statement.
Officials from the Fed and the Securities and Exchange Commission held conference calls throughout the day Thursday to assess the potential impact on the broader economy, according to a Treasury official, who spoke on condition of anonymity.
Just Thursday, Bear Stearns sought to soothe the market over the state of its liquidity. The bank said on Friday it sought to "confront and dispel these rumors," but didn't disclose the size of the financing that it arranged.
"The market chatter about liquidity risk actually resulted in a run on the bank against Bear Stearns," said Jane Caron, senior vice president and chief economist strategist at Dwight Asset Management in Burlington, Vt. "Even if they weren't in a liquidity crisis before, the rumors became self-fulfilling."
Bear Stearns has more exposure to the U.S. bond markets than its competitors, and has a large mortgage-backed securities business. It was among the first to disclose the impact of the subprime mortgage market meltdown when two of its leveraged hedge funds collapsed last summer, losing $1.6 billion.
"With the market's reaction, I'd say stick a fork in them, they're done," said James Ellman, portfolio manager at Seacliff Capital, a San Francisco-based hedge fund. "The company clearly has to choose from a set of unpalatable choices: sell a large amount of equity, sell the company outright or sell assets and try to hold on and hope for the best."
Treasury Secretary Henry Paulson praised the Fed’s leadership and said that the country’s financial system would be able to weather the problems.
“As we have been saying for some time, there are challenges in our financial markets and we continue to address them,” Paulson said in a statement. “This is another challenge that market participants and regulators are addressing. We are working closely with the Federal Reserve” and the Securities and Exchange Commission.
Paulson said he appreciated the leadership of the Fed “in enhancing the stability and orderliness of our markets.”
The action by the Fed board in Washington represented an endorsement of a rescue effort for Bear Stearns that had already been arranged by JPMorgan and the Federal Reserve’s New York regional bank.
It was seen as a last-ditch effort to save the investment bank, which has about 14,000 employees worldwide.
"They were the dominant firm for repackaging mortgages," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group LLC. "That's where all earnings came from. They had the least diversified earnings stream of all of Wall Street securities firms, and as a result, they're paying the price today."
Analysts said the news from Bear, which came just one day after investors had been soothed by a Standard & Poor's report that subprime mortgage-related writedowns are likely more than halfway done, suggested that the full impact of the global credit crisis has yet to be felt.
"This tells you we're not over the worst yet, and there are still some players out there who are vulnerable," said Stephen Dowds, head of international equities at Northern Trust in London.
"My guess is by next week, there will be rumors of other large, familiar institutions" that might be in financial trouble similar to Bear Stearns, said Anil Kashyap, a professor at the Graduate School of Business at the University of Chicago.