JPMorgan Chase & Co bought stricken rival Bear Stearns for a rock-bottom price while the U.S. Federal Reserve set an emergency interest rate cut and opened direct lending to Wall Street.
The shock news, the biggest sign yet of how devastating the credit crisis is for Wall Street, slammed the U.S. dollar to a new record low against the euro and pummeled Asia stock markets early on Monday.
"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."
The move will be seen as an attempt to prevent other major investment banks and brokers from suffering the same fate as Bear, the fifth-largest U.S. investment bank, as the pressures on the U.S. financial system from the credit market turmoil reach unprecedented levels.
Bear's major shareholders, including British billionaire Joseph Lewis and Bear Stearns' Chairman Jimmy Cayne, will have their holdings virtually wiped out by the deal, which will see JPMorgan pay only about $2 a share for Bear in JPMorgan stock.
The $236 million value of the deal, which is based on share count at the time of its annual report in January, compares with estimates of more than $1 billion that have been placed on Bear's world headquarters building on Manhattan's Madison Avenue.
Before it faced speculation about liquidity problems, which were quickly followed by a run on the bank last week, Bear's stock had been trading at around $70, and its 52-week high last April was at more than $159, valuing the company at about $24 billion at that time.
The pressures on companies like Bear prompted U.S. Treasury Secretary Henry Paulson on Sunday to say the U.S. government is prepared to do "what it takes" to maintain the stability of the financial system.
Bear Stearns' cash reserves were drained by fleeing customers on Thursday, and on Friday the bank secured emergency funding from the Fed, extended through JPMorgan Chase.
Bear Stearns trades interest-rate swaps, credit default swaps, and other derivatives with dozens of banks globally. If Bear Stearns went bankrupt, all of its trading partners could face big losses and fear could spread, which is why the Fed has been so instrumental in helping to arrange the rescue.
"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," Marin added.
JPMorgan Chase, the third largest U.S. bank and one of the few global banks relatively unscathed by the credit crunch, has sought to limit its liabilities in the deal by having the Fed fund up to $30 billion of Bear's less liquid assets.
Details of the risk that the Fed will take on in that part of the deal, and what the potential burden could be for U.S. taxpayers, were not immediately clear.
The Fed said on Sunday it cut the discount rate to 3.25 percent from 3.5 percent, effective immediately. It also unveiled a new lending facility at the discount rate for primary dealers - big Wall Street firms with which it deals directly in financial markets.
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 said in its statement that the boards of the two companies had unanimously approved the deal, through which Bear shareholders will receive 0.05473 shares of JPMorgan Chase for every Bear Stearns share.
JPMorgan will guarantee the trading obligations of Bear and its subsidiaries and provide management oversight of the operations.
The transaction is expected to close by the end of the second quarter as it already has fast-track approvals from the Fed and other federal regulators.
For JPMorgan, 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.
Bear Stearns has complicated mortgage bond and credit derivative assets on its balance sheet, and valuing them could be difficult. Bear 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, at the same time, renowned as an aggressive trader in credit and mortgage markets.
Bear generates a much bigger percentage of its revenue from the U.S. fixed income markets than its competitors, giving it few other businesses to lean on amid the global credit crisis.
In a classic run on the bank, many traders last week stopped doing business with Bear because they feared the firm might go bust, draining cash and making a collapse all the more likely. Hedge funds and other clients withdrew assets.
Following previous crises, famous firms such as Kidder Peabody, Salomon Brothers and First Boston were forced to seek buyers with robust balance sheets.
Bear last week accelerated plans to announced its first quarter results to Monday, at which time Bear is expected to disclose it cash position, capital levels and exposures to hard-hit assets.
Analysts on average expect Bear's first quarter earnings to plunge by more than half to $1.19 a share from $3.82 a share a year ago, and revenue to shrink to $1.4 billion from $2.5 billion, Reuters Estimates said on Sunday.