Bear Stearns is Gone, But Crisis Remains

The Fed move and the Bear sale indicate that there is great fear in banking circles that the crisis that began in the U.S. mortgage market could set off a chain reaction of defaults. The central bank took an active role in the Friday bailout of Bear by JPMorgan.

Apparently to keep any of the other big brokerage houses from running into the kind of troubles seen by Bear Stearns, the central bank also created a new loan facility that seems aimed at them. Primary dealers, a group of about 20 big banks and brokers that deal directly with the Fed in its monetary policy operations and in Treasury bond auctions, can borrow at the discount rate by posting "a broad range of investment-grade debt securities" as collateral.

This move effectively extends the discount window borrowings to the brokers since the banks could already tap the Fed, although they have historically been reluctant to do so because that would send a signal that they could not borrow money from the private sector.

The run on Bear Stearns accelerated late last week, after the company had spent several days trying to calm the markets by saying its liquidity and cash positions were fine. By Friday, the company had gone hat in hand to JPMorgan, which agreed to act as its go-between with the Fed for Bear to borrow emergency cash.

Bear Stearns Chief Executive Alan Schwartz said Friday that rumors had done the damage. "We have tried to confront and dispel these rumors and parse fact from fiction," he said. "Nevertheless, amid this market chatter, our liquidity position in the last 24 hours had significantly deteriorated."

JPMorgan will take over Bear Stearns in swift order. The deal is expected to close by the end of the second quarter, and has already gotten approval of bank regulators.