Bottoming process begins with Bear, not bear market

NEW YORK (Reuters) - Less than a week ago, it seemed like the sky was falling on Wall Street when the spectacular unraveling of investment bank Bear Stearns BSC.N sent financial markets, in the United States and elsewhere, into panic mode.

Then the Federal Reserve swooped in. Its liquidity action and its brokering of a deal for JPMorgan Chase & Co. (JPM.N) to take over Bear Stearns made investors less fearful about the probable crippling of the American banking system that could have occurred.

Bear Stearns' fall to the brink of bankruptcy and the aggressive moves by U.S. policy makers have led many investors to believe that these events mark the beginning of a bottoming process.

For everyone who still thinks that stocks won't hit a bottom until the Standard & Poor's 500 .SPX falls into the bear market's grasp, never mind.

"We are in a bottoming process, but it will really be a 'process' because healing of this credit crisis does take time," said Dan Fuss, vice chairman of Loomis Sayles, an investment company that oversees more than $100 billion in fixed-income securities.

What gives Fuss and other major investors reason to believe that a bottom is in the making is that in nearly every previous one, there typically has been a huge failure of an institution that has led to extreme policy responses.

Think Enron and WorldCom, Long-Term Capital Management and Orange County.

"It usually took a big entity to fall over for aggressive, creative regulatory policy to develop," said Bob Doll, vice chairman and global chief investment officer of equities at BlackRock Inc, which manages more than $1.1 trillion in assets.

"That's what we saw with Bear Stearns collapsing and the Fed's extraordinary response to it. And that's why confidence is improving," he added.

AN AVALANCHE OF FEAR

Bear Stearns, which had been heavily exposed to the faltering mortgage market, faced a classic "run on the bank" as the firm burned through cash and lost access to funding when clients furiously yanked assets and unwound trades.

To make matters worse, fears abounded that Lehman Brothers LEH.N, the fourth-largest U.S. investment bank, could suffer a similar fate as Bear, the fifth-largest.

"The Fed was trying to blunt what could have been a snowballing effect of a lack of faith in the financial system," said Keith Wirtz, president and chief investment officer at Fifth Third Asset Management, which manages $22.5 billion.

"The Fed saw that they had to do something absolute to stifle what could have been a developing crisis of a full-fledged lack of faith in the investment banking sector, which could have eventually crept into the commercial money banks as well," Wirtz said.

Before Monday, Lehman Brothers LEH.N, Merrill Lynch MER.N, and even venerable Goldman Sachs (GS.N) watched their stocks get "killed" last week, he added.

In fact, from the end of June 2007, which was the start of the credit turmoil, to March 14, 2008, before the Fed stepped in, Goldman's stock was down 28 percent, Lehman lost 48 percent, and Merrill also dropped 48 percent.

Moreover, the Amex Securities Broker-Dealer Index .XBD was down 48 percent.

PUSHING OPEN THE DISCOUNT WINDOW

On Tuesday, the Fed cut interest rates by three-quarters of a percentage point, the sixth time it has slashed its fed funds rate target for overnight bank loans, to 2.25 percent.

It wasn't, however, what prevented a near meltdown in stock markets.

The Fed dusted off a Depression-era rule to let securities firms borrow directly from the Fed through its "discount window" -- and that helped restore investors' confidence. That decision was announced along with the Fed's promise to underwrite JPMorgan's takeover of Bear for the "fire sale" price of $2 a share. It helped turn the mood around on Wall Street.

From now on, any bank in a liquidity jam will be able to go directly to the Fed's discount window and trade in its hard-to-sell assets, such as mortgage bonds, as collateral for highly liquid government bonds or cash, which it can in turn use to fund its short-term liabilities and keep trading.

"The big news this week was not the Fed's 75 basis points on Tuesday," Doll said. "It was what they did with opening the discount window .... that's a huge change."

This week, the Fed cut the discount rate twice -- in an emergency move on Sunday night, when it unveiled JPMorgan's deal to buy Bear Stearns at the almost unthinkable price of $2 a share and again on Tuesday at its regular meeting.

On Wednesday, the federal government came up with another tonic for troubled times. The regulator of Fannie Mae (FNM.N) and Freddie Mac (FRE.N), the two biggest U.S. home financing arrangement, relaxed their capital rules and gave them permission to pump $200 billion more into the struggling U.S. mortgage market.

Goldman shares are trading at $166.49 per share, up from Friday's close of $156.86, while Lehman is trading at $42.23 per share, up from its Friday close of $39.26.

As for Merrill, its shares closed at $41.45, down from $43.51 on Friday.

LETTING SOME AIR OUT OF OIL AND GOLD

Investors also believe the bottom has arrived for technical reasons. The Dow Jones industrial average .DJI and the S&P 500's have seen valuations that are much more subdued than when the markets had capitulated in the past.

"Everyone has been looking for the capitulation in the stock market, but they are looking at the wrong place," Wirtz said.

"Last week was very much a capitulation moment" in the financial sector, the root of the liquidity crisis, he added.

That's not all, folks.

Soon after the last bubble burst in technology and telecommunications stocks in March 2000, investors diversified away from U.S. equities.

"They've been buying foreign stocks and hard assets like commodities and real estate," Wirtz added.

Now everything from oil to gold to wheat are suffering from what looks like the beginning of a huge downdraft in those leveraged assets. U.S. crude for April delivery dropped nearly $5 to $104.48 a barrel, while gold tumbled 6 percent to a three-week low, under the $1000 mark to $940.40 an ounce.

"That's where all the leverage is coming out now, commodities," Fuss said. "I think stocks and bonds have gone through their worst beating."

"Down the road, last week will be looked at as an important moment in time for equity investors," added Wirtz of Fifth Third, who said the bottom is here.

(Additional reporting by Jonathan Stempel)