The wild ups and downs continue.

The stock market breathed a huge sigh of relief on Tuesday, as the Fed slashed rates yet again and Lehman Brothers and Goldman Sachs made a strong case for financial health. There were write-offs of a few billion here and there, but neither firm is expected to share Bear Stearns’ fate.

What happened to Bear Stearns has been equated to a classic “bank run,” where assets are pulled too quickly for the bank to survive. The most frightening thing about a bank run is the possibility of contagion -- the chance of setting off a domino chain, where one bank after the next succumbs to panic.

This time it was a run on the brokers instead of the banks. (Hence the Fed’s willingness to treat the brokers just like banks, in terms of special provisions and emergency credit lines.) When it became clear that the contagion was stopped -- at least for now -- investors cheered. All the brokers shot higher with moves in the vicinity of 10% or more.

Lehman Brothers, the firm most feared to have a death rattle, left everyone else in the dust. LEH jumped a whopping 46% yesterday on volume of more than 140 million shares. Of course, that huge move merely took Lehman’s stock back to where it was a week ago, before the panic began.

The Lehman jump was great news for everyone, including most of the 15,000 or so soon-to-be ex-Bear Stearns employees. If Lehman had gone down the tubes, a nameless Bear refugee pointed out, it would have become that much harder to find a new job.

Technically Not a Bailout… Yet

The sad fate of Bear Stearns’ thousands of employees brings up another fact. The Fed’s actions so far technically don’t count as a full-on bailout. Not yet at least.

It’s true the Fed threw billions in emergency credit lines at Bear, and that the government was a key player -- in fact, the key driver -- in setting up the JP Morgan deal. It’s also true that the Federal Reserve is taking on tens of billions of dollars in direct risk by guaranteeing Bear’s toxic assets.

The reason one could argue “no bailout,” at least thus far, is because Bear Stearns’ investors have basically been wiped out (including 15,000 or so employees, many of whom have seen their retirement funds destroyed along with their jobs).

Not Over Yet, Either

It’s really a gray area. There is still a credible argument that Bear Stearns has been nationalized -- or at least the balance sheet, at any rate. The Fed might not lose its entire $30 billion (the amount of coverage pledged to seal the deal), but it could easily lose a big chunk of it. And in the end, that money comes from taxpayers… the Central Bank of You and Me, as Jim Grant might say.

Everything is really still up in the air here. Not even the Morgan buyout is a sure thing. Bear Stearns’ investors are so furious, some are threatening to try to block what the Fed put together in an effort to get a higher price. (That’s partly why Bear Stearns’ stock, symbol BSC on the NYSE, is trading well above $2.)

Burned investors argue that Bear’s building alone is worth more than a billion bucks -- let alone other salvageable parts of the business -- and that a $2 valuation leaves them completely shafted.

Of course, these same investors have little to say about Bear’s black hole of a balance sheet. Who knows what kind of mystery meat, what horrible future blowups, lurk hidden in Bear’s trading book? What other buyer would be willing to step up without the Fed’s $30 billion guarantee?

It’s a big unholy mess that is set to get messier. We haven’t heard the last from Bear’s angry investors, and the Fed’s headaches are about to intensify.

All this, too, is set against a backdrop of worsening problems on the housing front and the consumer credit front. The real problem for the Fed is that, even if they’ve won a temporary battle, they haven’t won the war. There will be bigger, uglier battles ahead.

That’s why I remain convinced that we are in the preliminary stages of the biggest bailout in history -- even if the taxpayer money hasn’t been shelled out yet. We can see where this track is leading, and we can see that it’s going to cost us. Big time.

Wisdom or Folly?

It’s been argued that the Fed was wise to engineer the Bear Stearns rescue; not because Bear Stearns was “too big to fail,” but more because they were “too connected to fail.”

Just about every major bank and brokerage house in existence had dealings with Bear Stearns. If Bear had been allowed to simply shut down, balance sheets up and down Wall Street would have been thrown into chaos. That chaos would have shown up on Main Street in the form of denied loans, crashing stocks, blown-up pension plans and all manner of other financial horrors.

So, really, this argument goes, the Fed’s extraordinary efforts were an effort to save the system. Without the Fed’s unprecedented actions, the panic on Wall Street would have hit Main Street full force. Our finance-driven economy would have come to a shuddering halt… seized up like an engine with vapor lock.

How Did We Get Here?

On a pragmatic level, the arguments make sense. Given the circumstances, perhaps the Fed was just “doing what it had to do.” Perhaps the U.S. economy is so deeply leveraged and financially engineered that Wall Street has become the beating heart of everything.

In conditions like these, it’s hard to question the decision to have radical open heart surgery. But we can still question the foolishness and the stupidity that allowed Wall Street to become so grossly overextended in the first place.

At least one thing’s for certain: We haven’t seen the last of emergency measures and Hail Mary passes -- not by a long shot. In fact, we’re arguably still closer to the beginning of this whole mess than we are to the end. That has strong long-term implications for where investing and trading dollars should be… even if the financials are breathing a temporary sigh of relief and trading up for now.

Warm Regards,

JL

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