Bear fire sale sparks rout on eve of Fed rate cut

By Jack Reerink

NEW YORK (Reuters) - A fire sale of Bear Stearns Cos Inc stunned Wall Street and pummeled global financial stocks on the eve of an expected U.S. interest rate cut aimed at preventing a meltdown of the financial system.

On a day marked by gut-wrenching drops of financial shares such as Lehman Brothers, U.S. stocks almost ventured into bear market territory -- a drop of 20 percent from the October high.

The market staged a late partial recovery as optimism set in over an expected decision by the U.S. Federal Reserve to slash rates by as much as 1 percentage point on Tuesday to jump-start financial markets and prevent a recession. The cut would be the latest in a series that has brought down borrowing costs but hammered the U.S. dollar to record lows.

"They have spent some bullets. The Fed has a lot more bullets than we've seen so far," said Brian Edmonds, managing director of fixed income at Cantor Fitzgerald in New York.

Things looked bleak on Monday morning.

Staff at Bear Stearns' Manhattan headquarters were welcomed to work by a two-dollar bill stuck to the revolving doors -- a spoof on the rock-bottom price of $2 a share that JPMorgan Chase is paying for the firm. A hopeful Coldwell Banker real estate agent was hawking cheap apartments to employees who saw the value of their stock options go up in smoke.

The combination of Bear's swift bailout and the Fed's offer on Sunday to extend direct lending to securities firms for the first time since the Great Depression highlighted just how hard the credit crisis has hit Wall Street.

And it scared market players worldwide.

"If you get a crisis of confidence in the wholesale banking space and something the size of Bear Stearns could go under, then people start to panic. You get a real fear factor," said Simon Maughan, analyst at MF Global in London.

The grim mood spread. Investors bailed from rival Lehman for fear it would be next to face a cash crunch. Lehman shares plummeted 48 percent to a nearly 8-year low but partly recovered to close down 19 percent.

JPMorgan shares, by contrast, jumped 10 percent after the bank set a deal to buy Bear for $236 million, or a little over $2 a share -- a fraction of its 2007 high of $172.61. JPMorgan chief Jamie Dimon, a details-oriented Wall Street luminary with a track record of fixing up banks, also got the Fed to agree to guarantee up to $30 billion of Bear's hard-to-value assets.

"When you get the most severely damaged collateral and cover yourself to the tune of $30 billion, that cushion goes a long way," explained Bill Fitzpatrick, an analyst at Optique Capital, which owns shares of JPMorgan.

CONNECTIVITY - NOT ALWAYS A GOOD THING

Starting with packaging and reselling loans to U.S. borrowers with spotty credit, Wall Street's financial engineering led to a global boom in complex debt instruments that are now very tough to value.

Markets for these securities have dried up and caused multibillion-dollar losses at banks worldwide -- from the biggest names in banking to regional German banks few had ever heard of before disaster struck.