Update: Bear Stearns (BSC) shares plunged 27% Friday morning after the mortgage-heavy brokerage firm needed to be bailed out by a big money center bank with government backing.  

 JPMorgan Chase (JPM) agreed to provide the struggling broker with secured funding for 28 days. The financing will be backstopped by the Federal Reserve Bank of New York - the latest signal that federal officials are deeply concerned about the health of the financial sector and are trying to show investors that they will prevent big institutions from faltering. Bear Stearns admitted in its statement Friday morning that it was on the ropes before the deal came through.

“Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity,” CEO Alan Schwartz said in a company statement. “We have tried to confront and dispel these rumors and parse fact from fiction. Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations.”

The announcement comes a day after Bear Stearns shares fell as much as 17% amid worries the firm could collapse under the weight of declining values in the mortgage securities market. JPMorgan made a nod to those concerns in its announcement Friday morning. “Through its discount window, the Fed will provide non-recourse, back-to-back financing to JPMorgan Chase,” the bank said. “Accordingly, JPMorgan Chase does not believe this transaction exposes its shareholders to any material risk.”

JPMorgan also noted the possibility that mere financing may not be enough for Bear Stearns, whose shares have lost more than 60% of their value amid the ballooning mortgage problems of the past year. “JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company,” JPMorgan said.

Bear Stearns (BSC) is in a nosedive. Shares of the New York-based brokerage house plunged as much as 17% in morning trading Thursday as investors wondered how Bear will weather the latest downturn in the mortgage securities market. Thursday’s selloff took Bear shares down to $50 and change - less than a third of their price last year, before bad bets on subprime mortgages blew up two Bear Stearns hedge funds.

Since that episode, which led to several management shakeups at the firm, billionaire investor Joseph Lewis has been buying the stock with abandon. Bloomberg reported Tuesday that Lewis, now Bear’s second-biggest shareholder with a 9.4% stake, was considering buying even more stock in the wake of its recent selloff. He is surely hoping his luck will turn at some point: Lewis made the bulk of his purchases back in July, when Bear Stearns shares traded between $120 and $145. With Treasury Secretary Henry Paulson warning Thursday that the financial markets are in for more stress, it may be a while before the stock sees those levels again.

Bear Stearns (BSC) missed the early part of Tuesday’s Fed-fueled financial sector rally after an analyst warned that the struggling brokerage firm might be forced into a merger. Analyst Richard Bove cut his price target to $45 a share from $67 and reduced his 2008 earnings estimate by more than half. “The problem is Bear’s business model is broken,” Bove said, according to Bloomberg.

Bove’s move comes a day after Bear Stearns shares dropped sharply in spite of comments by CEO Alan Schwartz that “there is absolutely no truth to the rumors of liquidity problems.” Bear survived an earlier round of liquidity worries in the second half of last year, in part by cutting a capital-raising deal with China’s Citic. That deal is now being renegotiated to reflect sharp declines in both companies’ share prices.

This month’s credit market panic aside, the big problem for Wall Street is gauging the firm’s future health. Punk Ziegel’s Bove says Bear’s dependence on the fast-deteriorating mortgage business means it won’t match its 2006 profits for years, which he said is reason to sell the stock. Investors did so with gusto, sending Bear Stearns down as much as 10% to a low last seen in late 2002. Update: Bear Stearns share rallied in late afternoon trading as the financial sector surge accelerated, sending the Dow Jones Industrial Average up 360 points, or 3% - its biggest single-day percentage gain in five years.

Another obscure corner of the debt market is causing pain for taxpayers. States and cities selling municipal bonds are finding they have to pay more to issue so-called variable-rate demand notes, The Wall Street Journal reports. As with the collapse earlier this month of the now infamous auction-rate securities market, the problem is that Wall Street dealers such as Bear Stearns (BSC) and Morgan Stanley (MS) have stopped buying the debt, which allows municipalities to borrow for the long term at lower short-term rates. The dealer pullback has caused demand to dry up and interest rates to spike. The rate California paid on a recent $300 million issue quadrupled to more than 8%, the Journal reports.

Meanwhile, in a novel twist, the failure of the notes to sell at auction could leave them piling up on the balance sheets of so-called backstop banks such as Bank of America (BAC) and Citi (C), which are already stuck with billions of dollars of loans and other assets they can’t sell. That’s not even the worst news in the municipal bond market, though: Bloomberg reports that the California city of Vallejo is near a bankruptcy filing brought on by the collapse of the housing market, which has resulted in lower tax revenue, and rising pension costs. “Bankruptcy is a last resort,” councilwoman Joanne Schivley said, Bloomberg reports. “But guess what folks, that’s where we are now at.”

More trouble for Citi (C). The bank stopped investors from pulling their money out of a hedge fund that specialized in corporate debt after the fund, CSO Partners, posted an 11 percent loss for 2007, The Wall Street Journal reports. The Journal reports Citi injected $100 million to stabilize the fund, which has about $500 million in assets but faced an attempt by investors to withdraw 30 percent of the fund’s money.

Citi isn’t the only financial titan with hedge fund problems, though. The Journal reports that investigators are probing whether former Bear Stearns (BSC) fund manager Ralph Cioffi misled investors on an April conference call that was held just  months before the firm admitted that two in-house hedge funds had collapsed. On the April call, the Journal reports, Cioffi said he was “cautiously optimistic” about the funds, which made leveraged bet on subprime mortgage-backed securities - despite the fact that he had just pulled $2 million of his own money from the funds. Cioffi’s lawyer is considering making him available to prosecutors for informational interviews, the Journal adds. Perhaps he’ll tell investigators that he really needed to diversify his portfolio.

Plunging share prices are strengthening the ties between Bear Stearns (BSC) and a big Chinese bank. Citic Securities, the state-owned securities company, and Bear are renegotiating the terms of a $1 billion securities swap they worked out in October, the Financial Times reports. The revised deal will give Citic a nearly 10 percent position in the New York-based brokerage firm, up from the 6 percent stake Citic was supposed to gain when the deal was originally struck. In return, Bear will get a stake in Citic as big as 7.5 percent, up from the earlier plan of 2 percent.

The renegotiation came about because shares in both companies have dropped sharply since the deal was announced, China’s Xinhua news agency reports. Since October, Bear Stearns stock is down 33 percent and Citic’s Shanghai-listed shares are down some 36 percent, Xinhua says. Another factor is that Chinese authorities, noting the decline in other Wall Street investments they’ve made ranging from Blackstone (BX) to Morgan Stanley (MS), must be eager to show they’re keeping a close eye on their money. Obviously Bear Stearns stock is a better buy at $80 than it was at $120, but going by Thursday morning’s 2 percent decline, even now Bear stock is far from a surefire winner.

Add Bear Stearns (BSC) to the list of Wall Street firms shuffling top management as the mortgage crisis drags on. CEO Jimmy Cayne will step down as chief executive but remain chairman, The Wall Street Journal reports, after a year that saw the firm report its first-ever quarterly loss and found Cayne playing golf during a hedge fund crisis that eventually cost investors $1.6 billion. The Journal reports that Cayne chose to depart after big investor Bruce Sherman told at least one director that he wasn’t happy with the stock’s year-long plunge. Cayne joins Merrill Lynch’s (MER) Stan O’Neal and Citi’s (C) Chuck Prince in taking the fall after big losses tied to big debt market bets. The question now is whether Bear Stearns’ shares, down more than 50 percent over the past year, can find some support as the firm tries to move forward in a declining earnings environment. The precedent at Merrill and Citi, which along with other financial stocks have fallen sharply this year, isn’t promising. As Sanford C. Bernstein analyst Brad Hintz told Bloomberg, “This is going to take a long time to play out.”

Bear Stearns (BSC) sank to a new low in heavy trading Wednesday after an insider slashed his stake in the struggling investment bank. Director Paul Novelly sold 50,000 shares last week at $86.78 apiece, Reuters reports. The sale, which netted Novelly $4.3 million, leaves him with 125,000 shares, according to Securities and Exchange Commission filings.

Novelly, who runs privately held Apex Oil and has been on the Bear board since 2002, built up much of that stake last year at much higher prices, just before the firm ran into deep trouble with bad bets on the imploding mortgage market. Novelly bought around 100,000 Bear Stearns shares in the first quarter of last year - including a three-day, $7.4 million buying binge last March at around $148 a share. At recent prices, that bet is under water to the tune of $3.2 million.

Novelly’s folly shows that even insiders, whose actions are keenly observed by other investors, aren’t a foolproof gauge of a company’s health. As one observer told the St. Louis Business Journal in laying out the merits of tracking insider purchases, “The insider seems to think things are going well or the shares are underpriced.” In this instance, the insider seems to have been sadly mistaken.

By James Ledbetter

You may not be old enough to remember this, but once upon a time, the New York Times business section was really, really bad. A distant poor cousin to the Wall Street Journal, the “D section” as it was then - I’m talking through the late ’80s - was late and colorless on the stories it didn’t miss altogether. It is infinitely better today, competing story-for-story with the Journal, and featuring several must-read writers, including Floyd Norris (who’s admittedly been around since the darker days), Joe Nocera, and even - it surprises me to say it - Gretchen Morgenson.

Still, there are mornings when the paper publishes something that feels like a blast from the poorly thought-out past. The lead business feature today, headlined “Not a Jolly Season For 2 Top Bankers,” is an example. The premise is sound enough: James E. Cayne of Bear Stearns (BSC) and John Mack of Morgan Stanley (MS) have had terrible years, and there ought to be pressure from shareholders and others for them to go, as was the case for Citi’s (C) Charles Prince and Merrill’s (MER) Stanley O’Neal.

So far, OK. But the article begins to drift in the fourth paragraph:

As losses from the spreading mortgage crisis mount on Wall Street, the question of whether chief executives should stay or go has become a sensitive issue for boards and the executives themselves.

Leave aside the obvious point that for most chief executives, it’s always been a sensitive issue whether they stay or whether they go, and it always will be. The article then goes on to contradict itself. It says: “So far, there has been no public outcry from investors or internal revolts at Bear Stearns and Morgan over the fact that Mr. Cayne and Mr. Mack are staying on.” But just a few paragraphs later, a securities analyst from Punk Ziegel (love that name!) is quoted saying: “Investors are telling me that [Cayne] should go. He has a mind-blowing loss that is his fault, and he should take responsibility for it.” That kind of sounds like an outcry (though I suppose one could debate whether it is public).

But the biggest sin this story commits is to completely miss what IS different about this era. And that is: one reason why boards or investors might be reluctant to dump underperforming executives is because they don’t want to pay for the privilege. As my esteemed colleague Allan Sloan has pointed out, these top Wall Street executives get paid tens of millions of dollars a year, even when their firms post staggering losses. It would take even more millions to make them leave, and then you’ve got little guarantee that the next person will do any better. As long as that kind of money has to be shelled out, you may as well get some work out of them. I don’t know why the Times omits this rather obvious and overwhelming fact; perhaps it is a “sensitive issue.”

As investors brace for Bear Stearns (BSC) to deliver the next round of bad news from Wall Street, FTAlphaville is turning a skeptical eye on Wednesday’s finger pointing at Morgan Stanley (MS). The big brokerage firm posted a $3.6 billion fourth-quarter loss, mostly as a result of $9.4 billion in writedowns tied to subprime mortgage-related securities.

CEO John Mack and finance chief Colm Kelleher made a point of blaming ”trading by a single desk in our mortgage business,” but FTAlphaville takes issue with the notion that “trading” was the problem at all. It notes that much of Morgan Stanley’s loss was tied to a big holding of so-called super senior tranches of CDOs — which, until recently, was seen as among the safest nongovernment paper around. “For a start,” Sam Jones writes, “why make such a huge, singular bet on such a dull, low-yielding product?”

Why indeed? Because, Jones continues, slicing and dicing products like collateralized debt obligations, and applying leverage to them to make them more profitable, has become standard operating procedure in the banking industry. Doing so while times were good padded the banks’ bottom lines, and now, with markets cranky and risk-averse, the banks’ lax attitude toward risk is coming back to haunt them.

Either way, what happened to Morgan Stanley is no aberration, Jones suggests. “Morgan Stanley’s super senior exposure goes way beyond being the responsibility of ‘one desk,’” he concludes. “It’s a pretty accurate reflection of banks’ way of conducting business in general.”