The Federal Reserve Bank of New York and JPMorgan Chase yesterday teamed up to bail out Bear Stearns in a move that saw America’s central bank invoke emergency loan legislation for the first time in 50 years.

Bear Stearns, America's fifth largest investment bank, warned Wall Street that it was not certain it would survive but that it was seeking alternative means of funding. Shares in the bank plunged to their lowest level for a decade, and it confirmed it had asked fellow investment bank Lazard Brothers to advise on the options for its future, including a sale or break-up.

Despite the state intervention, traders were dubious on its chances. Hedge funds and prime brokerages shut down their trading positions with the bank, increasing the likelihood of it running out of cash. The cost of insuring against its collapse soared to an all-time high late on Friday, and Moody's, the credit-rating agency, warned the bank faced an uncertain future "if a long-term stabilising solution is not quickly achieved".

The predicament of America’s fifth largest investment bank triggered a 250-point fall on the Dow Jones industrial average, which ended the day down 194.60 points at 11951.10, and a surge in Treasury bond-buying as traders dived towards safe assets amid fears that Bear Stearns may go bust.

Bond traders immediately priced in an interest rate cut of three quarters of a percentage point when the Federal Reserve Bank meets next week, bigger than the 50-basis-point cut previously expected. The bigger reduction would take the cost of borrowing to 2.25 per cent.

In a statement yesterday morning, Bear Stearns said: “Our liquidity position in the last 24 hours had significantly deteriorated.”

The bulk of Bear Stearns’s business is derived from its mortgage and fixed-income business, which means that it has been particularly exposed to the housing crisis in America and the credit crisis that erupted in the summer. The bank explained that it had appointed JPMorgan Chase as an adviser to examine how to secure long-term financing and that its bigger rival had agreed to lend Bear Stearns funds for 28 days on a secured basis. Bear Stearns also managed to secure an emergency loan from New York’s Federal Reserve Bank. It is not known what either bank is charging for the loans, or what is their size.

The loan required America’s central bank to invoke an emergency safeguard of the Federal Reserve Act, called the 10b5 provision, which allows Washington to lend any US corporation money if no other funding is available and where the demise of that company threatens the US economy as a whole. The provision has not been invoked for 50 years.

Alan Schwartz, chief executive of Bear Stearns, said yesterday: “Concerns on the part of our counterparts and customers got to the point where a lot of people wanted to get cash out. We were meeting those needs but they accelerated late in the day. The pace things were going meant that liquidity demands would have outstripped liquidity resources.”

Mr Schwartz added that the bank’s adviser, Lazard Brothers, the investment bank, told its client to approach the New York Federal Reserve and JPMorgan.

JPMorgan and Lazard are seeking ways of securing long-term funding for the bank, but Bear Stearns gave warning that “the company can make no assurance that any strategic alternatives” to fund itself in the long term “will be successfully completed”.

Bankers outside Bear Stearns believe that the collapse of the Carlyle Capital Corporation, an investment fund owned by Carlyle, the US private equity giant, on Thursday was the nail in Bear Stearns’s coffin.

The bank, which was heavily involved in lending to hedge funds, had lent about $1.6 billion (£791 million) to CCC and may have been forced to take mortgage-backed securities in lieu of its cash when the fund went bust. But the value of the securities plunged, fuelling existing fears that Bear Stearns was running out of money. As a result, the bank’s lenders started calling in their loans.

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