Bailout aimed at stabilizing Bear Stearns

After fighting off rumors all week it was facing a crippling cash crisis, Bear Stearns bsc roiled financial markets on Friday with news it had turned to the federal government and JPMorgan Chase jpm for a bailout.

Stock in the USA's fifth-largest investment bank plunged $27 Friday to close at $30 — a 47% drop that erased more than $3 billion in market value.

The selling spread to the broader market, and the Dow Jones industrials closed down 194 points at 11,951 after rebounding from a more-than-300-point drop.

Bear Stearns said it sought emergency funding after realizing it would not be able to keep up with a surge in demand from lenders and others trying to get their cash back.

Those demands forced the 85-year-old institution to reach a financing agreement with JPMorgan Chase so it can continue operating.

CEO Alan Schwartz said without the temporary financing, customer withdrawals would have outstripped the bank's ability to make payments.

Rumors have persisted that Bear faced major cash flow problems; Schwartz initially denied those rumors. Through Thursday, its shares had already dropped 18%. "Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity," Schwartz said Friday. "Amidst this market chatter, our liquidity position … had significantly deteriorated."

Bear's weakened position has also raised questions among some of its customers, including the state of California, which had planned on using the firm for upcoming sales of government-backed bonds.

The Fed approved Bear's request for a bailout and the firm announced it Friday morning. The Fed's decision recalls previous attempts to rescue financial institutions deemed "too big to fail," says Hugh Johnson, chairman of Johnson Illington Advisors.

"This is a confidence issue," says Brad Hintz, analyst at Sanford Bernstein. "The brokers are adequately capitalized. But the bond market and creditors are apprehensive about lending to the brokers and taking counterparty risk."

Bear Stearns has struggled since last year because of the fallout in the mortgage and credit markets. Last summer, two of its hedge funds worth billions of dollars collapsed because of bad bets on securities backed by subprime mortgages.

In a memo sent to employees, Schwartz said the temporary financing would allow the company to "get back to business as usual."

Contributing: Sue Kirchhoff in Washington; wire services