JPMorgan Chase set a deal to buy stricken rival Bear Stearns for a rock-bottom price, while the US Federal Reserve expanded lending to securities firms for the first time since the Great Depression to prop up the financial system.
The shock news, the biggest sign yet of how devastating the credit crisis is for Wall Street, slammed the US dollar to a record low against the euro, pummeled Asia stock markets and boosted gold and low-risk bonds.
The Fed also made an emergency quarter-point cut in its discount rate and agreed to finance up to $30 billion of Bear's assets as US Treasury Secretary Henry Paulson pledged the US government is prepared to do "what it takes" to maintain the stability of the financial system.
"The fear is how many more skeletons in the closet are still there in the global credit markets?" said David Cohen, economist at Action Economics in Singapore.
"This is another effort by the Fed to calm things down, but the cloud on the horizon is just how much more of these credit issues are still out there."
Faced with an economy that may already be mired in recession, the Fed is expected to pull another tool out of its box on Tuesday by slashing its key benchmark overnight interest rate by as much as 1.25 per cent.
It has already cut the rate by a total of 2.25 percentage points to 3 per cent since mid-September -- putting downward pressure on the US dollar.
The Fed's latest moves were seen as an attempt to prevent others from suffering the same fate as Bear, the fifth-largest US investment bank. Bear in essence faced Wall Street's version of a run on the bank as customers stopped trading with the firm and demanded their cash late last week.
On Friday, shares of rival Lehman Brothers were battered on fears it might lose investor confidence next, though a half-dozen hedge funds Reuters spoke to were trading with Lehman and Lehman insisted it was in good shape.
Bear's predicament shows how fast things can change on Wall Street.
JPMorgan is paying just $2 a share for Bear, or a total of $236 million, although the bank put a total $6 billion price tag on the deal including litigation and severance costs.
Still, the per-share payout is just one-fifteenth of Bear's stock price on Friday and miles off its record share price of $172.61 last year.
That means Bear's shareholders, including British billionaire Joseph Lewis and Bear Stearns' Chairman Jimmy Cayne, will have their holdings wiped out by the deal.
"It's scary for what it says about the value of financial assets, if a company is worth only a small percentage of book value," said Emanuel Weintraub, managing director of Integre Advisors, a New York-based money management firm.
Bear Stearns, which has more than 14,000 employees, trades interest-rate swaps, credit default swaps, and other derivatives with dozens of banks globally. If Bear Stearns went bankrupt, its trading partners could face big losses and stop lending, paralysing the global financial system
"It wouldn't just be Bear's problem, it would be everyone's problem," said Marino Marin, an investment banker at Gruppo, Levey & Co who has restructured banks in the past but is not involved in this deal. "It would be apocalyptic."
That's why policymakers moved swiftly on Sunday.
The Fed cut its discount rate to 3.25 per cent from 3.5 per cent and unveiled a new lending facility at the discount rate for primary dealers -- big Wall Street firms with which it deals directly in financial markets.
"Desperate times need desperate measures. The Federal Reserve is doing what it takes to restore stability and it means cutting the discount rate on a Sunday night in the US, then so be it," said Craig James, the chief equities economist at CommSec in Sydney.
Bear Stearns, one of 20 primary dealers, had been unable to borrow directly from the window, because it had previously been open only to deposit-accepting banks.
JPMorgan wrapped up the deal in record time. It said the boards of the two companies had unanimously approved the deal that gives Bear shareholders 0.05473 shares of JPMorgan Chase for every share.
For JPMorgan and its CEO Jamie Dimon, the deal may turn out to be a rare opportunity, some analysts said.
"JPM is getting the number three prime broker, a solid merchant banking portfolio, a good high net worth business and a mortgage servicing business for well below its market value. But BSC has no choice but to sell," said Bernstein Research analyst Brad Hintz.
Dimon is known as a details man, a whiz at numbers and has a track record of fixing up major banks. By working with the authorities to rescue a financial institution, he is following a JPMorgan tradition begun by JP Morgan himself in 1907, when he rescued the New York Stock Exchange and other institutions.
The potential downside: Bear Stearns has hard-to-value mortgage bonds and credit derivatives on its books. It may also face legal liability from soured subprime mortgage bonds and other instruments it sold, analysts said.
CRISIS OF CONFIDENCE
Investors lost confidence in Bear in recent weeks because it is the smallest of the major investment banks and was known as as an aggressive trader in credit and mortgage markets.
Bear generates a much bigger percentage of its revenue from the US fixed income markets than its competitors, giving it few other businesses to lean on amid the global credit crisis.
Much like to depositors lining up to pull money from bailed-out British bank Northern Rock, many traders stopped doing business with Bear because they feared the firm might go bust.
That drained Bear's cash and made a collapse all the more likely.
Following previous crises, famous firms such as Kidder Peabody, Salomon Brothers and First Boston were forced to seek buyers with robust balance sheets.
JPMorgan, which will guarantee Bear's trading obligations and provide management oversight, expected to close the deal by the end of the second quarter as it already got fast-track approvals from the Fed and other federal regulators.
"This deal had to happen, and JPMorgan is the best candidate for this because their capital position is stronger and their sources of funding are stronger," Weintraub said. "I do think this is the best possible scenario for financial markets." (Reuters)
JPMorgan to buy Bear Stearns