NEW YORK (Reuters) - Bear Stearns, slammed by a sudden cash crunch, hammered out an emergency funding deal with the Federal Reserve and JPMorgan Chase, intensifying fears the global credit crisis will claim more victims and driving Bear's shares down by as much as half.
It was the Federal Reserve's first rescue of a broker since the Great Depression and its latest effort to soothe financial markets roiled by fallout from rising mortgage defaults.
The 28-day emergency line of finance on Friday came just two days after Bear, which has been hard-hit by its heavy exposure to the faltering U.S. mortgage market, dismissed market rumors of a cash shortage and said it still was a healthy player in the global web of trading and finance.
But its tune changed Friday. Bear Stearns' chief executive, Alan Schwartz, explaining why the bank turned to the Fed and a rival bank, said: "Our liquidity position in the last 24 hours had significantly deteriorated.
"We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations," said Schwartz.
But inside Bear, the fifth largest U.S. bank, and on Wall Street, the view was grim.
"The mood is somber," said one Bear Stearns equities salesman who declined to be quoted by name for this story. The buzz at the firm was that there could be a takeover deal as soon as Monday, he said.
Investors fled. Bear stock plunged on record volume, closing down 45.9 percent at $30.85 and shearing $3.2 billion off its market value. Earlier, the stock fell as low as $28.42, its lowest price since the 1998 Asian debt crisis.
And Bear debt default insurance surged to a record amid fears for the bank's future, and demand for put options remained strong on bets the stock will fall further.
The news bashed other financial stocks and dragged down both U.S. and European markets. The Dow Jones index shed 194 points to close at 11,951, and the pan-European FTSEurofirst 300 index closed down 1.1 percent, led by bank shares.
Though Bear has been one of the hardest hit banks during the credit crisis, it stunned investors by announcing that the Federal Reserve Bank of New York and JPMorgan agreed to provide an unspecified amount of secured funding for up to 28 days.
The Fed will provide financing to Bear through JPMorgan, which said it is working closely with Bear "on securing permanent financing or other alternatives." The Fed approved the arrangement in an emergency meeting Friday morning.
Treasury officials participated in a series of conference calls beginning on Thursday with the Fed, the New York Fed and the Securities and Exchange Commission as it became apparent that Bear's problems could damage the broader financial system, a Treasury official said.
JPMorgan, which has largely avoided the financial losses that have hobbled Citigroup and other investment banks, also has much at stake. As one of the largest players in debt and derivatives markets, it would face losses if Bear is unable to meet its obligations.
The news from Bear, which came just one day after Standard & Poor's soothed markets that subprime mortgage-related write-downs 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. "We expect more transparency next week when we get results from the U.S. financial sector.
Some investors fear Lehman Brothers Holdings Inc, the No. 4 bank, could end up in a similar bind. Lehman spokesman Randy Whitestone said the bank is in good shape.
Shares of Lehman Brothers Holdings Inc, fell 14.6 percent to $39.26, Morgan Stanley fell 4.9 percent to $39.55, and Goldman Sachs Group Inc fell 5.2 percent to $156.86.
Bear Stearns is often seen as one of the most vulnerable investment banks because it is the smallest of the major New York firms and the most reliant on slumping U.S. mortgage markets.
Bear's reputation as a savvy trader was hurt last summer by the collapse of two mortgage hedge funds, and it suffered losses on its mortgage and credit exposures.
The last straw came this week as deterioration in the markets and the continued struggles of mortgage companies sparked a loss of confidence among traders in Bear.
Schwartz disclosed that the bank's liquidity position "significantly deteriorated" on Thursday, after a series of reports raised questions about Bear's ability to deliver on long-term trades. Schwartz on Wednesday had said the bank had about $17 billion in cash, little changed from February 29.
"At the pace things were going, we recognized it could be that continued liquidity demands would outstrip our liquidity resources," Schwartz said in a statement. "We felt the need to move quickly to conduct normal operations to calm things down and let some facts into the marketplace."
European traders at major banks, however, were ordered by their firms to stop dealing with the stricken U.S. bank, worried that it may default on trades, sources told Reuters.
Bear Stearns, JPMorgan and the Fed declined to comment. A source briefed on the situation said that without the Fed's intervention Bear would not have had enough cash to open for business Friday.
"I think this is a bridge to a permanent solution," Schwartz said on a conference call. He said the lending facility is sufficient for Bear to fund its daily activities, conduct "business as usual."
Yet he left the door open to pursuing other deals.
"We'll be looking for any strategic alternative that allows us to protect our customers as well as maximize shareholder value, and we'll look at a range of alternatives," he said.
"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."
Veteran bank analyst Dick Bove, with Punk Ziegel & Co., played down the speculation of an immediate sale, saying such a transaction would not be possible while the Fed is involved.
"The fact of the matter is no one is willing to buy Bear," he said.