NEW YORK -- Bear Stearns Cos., one of Wall Street's biggest investment banks, got an emergency loan from the Federal Reserve today to help it stay in business, a dramatic development that threatens to take the global credit crunch to a dangerous new level.

The news sent the stock market plummeting, although key indexes closed above their worst levels of the session.

The Dow Jones industrial average closed down 194.65 points, or 1.6%, to 11,951.09. The index had been down as much as 313 points.

Bear Stearns shares plunged $27 to $30, a loss of 47%. Early last year, they traded at almost $160.

The securities firm, which has suffered major losses stemming from the sub-prime mortgage meltdown, said its ability to meet its short-term obligations had "significantly deteriorated" in the last 24 hours as rumors about its financial condition swirled in the market.

Wall Street rival JPMorgan Chase & Co. said it would borrow an undisclosed amount of money from the Federal Reserve Bank of New York, then lend that money to Bear Stearns.

"We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations," Alan Schwartz, Bear Stearns' chief executive, said in a statement.

The need for the emergency funding underscored the fragility of the financial system and raised questions about whether a global crisis of confidence could undermine other leading Wall Street firms with effects that could cascade through the economy.

As a wide range of companies, hedge funds and others have been laid low by the sub-prime crisis and credit crunch, their creditors have balked at doing further business with them and often have required the borrowers to put up additional capital that has been hard to come by.

The action also cast Bear Stearns' future into doubt and raised the likelihood that the firm could be forced into a takeover by a competitor.

"We've received plenty of directives from our clients today telling us to do no business with Bear Stearns," said Jeffrey Gundlach, chief investment officer at Los Angeles-based TCW Group, parent of Trust Co. of the West.

Investors, he said, see no reason to take the risk of having money with a troubled brokerage when there are many other firms they can use.

"Bear Stearns as we know it is gone," said Allen Sinai, a veteran Wall Street economist and head of Decision Economics Inc. in New York.

The state of California today sought assurance from Bear Stearns that it could honor its commitments in two large state bond sales the firm managed this week -- a $1-billion deal for the Department of Water Resources and a $302-million deal for the Public Works Board.

Samuel Molinaro, Bear Stearns' chief financial officer, replied in a letter to the state that the emergency funding the firm received gave it "sufficient liquidity to continue normal operations ..... and meet all obligations."

The Federal Reserve Board voted 4-0 to approve the loan bailing out Bear Stearns this morning shortly before its 10:23 a.m. Eastern time announcement of the action.

The board normally has seven members, but two positions currently are unfilled and governor Frederic S. Mishkin was traveling and unable to participate in the decision.

The exact amount of the loan will depend on Bear Stearns' needs and how much collateral it has to put up to secure the loan, people familiar with the arrangement said.

The loan is being entirely funded by the Fed and its New York branch, and the risk that Bear Stearns could default on the loan rests solely on the Fed. JPMorganChase simply is acting as a conduit for the transaction.

The central bank normally lends only to commercial banks. But the Fed Board and the New York Fed acted under authority granted them in 1932 during the early stages of the Great Depression, when a new section was added to the Federal Reserve Act. The new section authorized the board and the reserve banks to make so-called discount window loans directly to "individuals, partnerships and corporations," but only in emergency situations.

The section says that these loans require the approval of at least five Fed Board governors. But it adds that approval can be granted by fewer than five, as happened in this case, if the board vote is unanimous, "unusual and exigent circumstances exist and the borrower is unable to secure adequate credit accommodations from other sources."

Despite five cuts in its key short-term interest rate since September, the Fed has been unable to halt a tightening of credit across the financial system.

The root of the problem is that banks, brokerages and investment funds have lost tens of billions of dollars on mortgage-backed bonds because home loan defaults have soared. But the credit crunch now has spread far beyond the housing sector.

The Fed on Tuesday took the unprecedented step of agreeing to temporarily lend major banks and brokerages $200 billion in Treasury securities it owns, in exchange for mortgage-backed bonds that have slumped in price. The move was an effort to halt the erosion in the value of mortgage securities and bolster financial institutions' balance sheets, hoping they'll feel more comfortable resuming normal lending to their customers.

The program might have helped Bear Stearns, but the first such swap by the Fed won't occur until later this month.

Meanwhile, the Fed is expected to continue its rate-cutting campaign next week. Policymakers on Tuesday are expected to cut their benchmark rate from 3% to at least 2.5%. Some analysts today said the cut could be as much as a full percentage point.

Times Staff Writer Peter G. Gosselin contributed to this report.

walter.hamilton@latimes.com
tom.petruno@latimes.com