Bear Stearns Hits the Panic Button

You know those "easy buttons" Staples touts in its commercials? Bear Stearns could really use one of those today.

Once a heavy hitter among Wall Street investment banks, Bear Stearns (NYSE: BSC  ) fell more than 50% at one point Friday, after announcing that it would receive short-term financing from the Federal Reserve and rival JPMorgan Chase (NYSE: JPM  ) . Shares now trade at Bear's lowest levels in more than a decade.

The move came after rumors of Bear's liquidity woes proved true. For the past week, chatter surrounding the banker's ability to keep liquidity up to par spooked Bear's clients, sending even more fear through an industry already rattled to the core.

JPMorgan will essentially act as a conduit between the Federal Reserve and Bear Stearns, borrowing money from the Fed's discount window and lending that money out to Bear. JPMorgan won't shoulder any risk of Bear defaulting on those loans, since the Fed has agreed to be left holding the bag if Bear's collateral continues to tank.

Why did JPMorgan get dragged into this mess to begin with? As a commercial bank, JPMorgan can draw on the Fed's discount window, borrowing at cheap rates; investment banks like Bear Stearns and Lehman Brothers (NYSE: LEH  ) aren't easily able to do that. On Tuesday, the Fed announced it would provide some $200 billion in assistance to financial companies struggling to tread water in the debt market, but that plan doesn't kick in until later this month. The fact that Bear couldn't wait that long to seek help sheds light on the direness of its situation.

Even the best fall down sometimes
While many Wall Street firms have undergone a tumultuous few months, it isn't much of a surprise that Bear Stearns is the first to really take it on the chin. Bear focused on an area of the market that sits at the forefront of current market turmoil: debt. That focus allowed its stock to jettison faster than other Wall Street shops like Goldman Sachs (NYSE: GS  ) in past years, yet it's now boomeranging back in its face quicker than many imagined.

At the end of November, Bear Stearns held more than $35 billion in liquid investments -- more than enough to service its short-term debt. Now, a matter of months later, Bear seems to be limping to Uncle Sam just to stay afloat.

Sure enough, the debt market, especially involving mortgages, is in a freefall approaching unprecedented speed. Just in the past week, steep plunges from the likes of Thornburg Mortgage (NYSE: TMA  ) and Carlyle Capital -- institutions thought by many to be conservative and well-capitalized -- have sent investors searching for answers. In the fast-paced world of finance, forget tomorrow; success can be here today, gone today.

Bear's next steps
With shares now down 75% over the past year, a broken business model, and recent liquidity troubles stoking the flames, Bear's future seems in jeopardy. If the banker can keep its doors open at all, it likely faces a buyout by a rival at some point soon. For investors sitting on big losses and hoping for a rebound, that won't come as welcome news, and it likely fueled some of Friday's plunge.

Take it or leave it
Friday's events highlight two points that leave investors with more to chew on. The credit crunch could be worse than even the most pessimistic forecasters thought, putting the demise of Wall Street banks on the line. On the upside, the Fed is willing and able to step in and provide help to those banks when times get really tough.

Whichever of those two points proves dominant in investors' emotions will likely set the tone for the financial industry over the next several weeks. Grab a cappuccino -- it's going to be a long and bumpy ride ahead.

Until then, check out this related Foolishness:


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