Friday’s bailout of Bear Stearns (discussed here) means a couple of thick, fat lines have been crossed.

The truth of the matter is this:  Bear Stearns is done.  It’s on the block, and the Fed’s bailout only served to allow the company to change hands in a semi-orderly fashion.  Indeed, Saturday the company was said to be in talks with two other Wall Street firms for a buyout.

Department heads at Bear Stearns met with officials at J.C. Flowers and JPMorgan Chase Saturday afternoon to give an overview of their business divisions, including headcount and profit and loss positions, CNBC has learned.

The discussions indicate that potential bidders for Bear have been narrowed to those two firms, although other last minute contenders could still weigh in, according to one source aware of the talks.

While Bear would certainly like more bidders, time has become a major issue for the investment bank.

Bear Stearns is out of time.  The Fed is taking on its debt, having swapped it out for a short-term loan that will of course be forgiven.  The company will not survive and once the deal is announced, it will largely be forgotten.

Why?

Because much worse news is on the way.  The Fed’s reaction to Bear Stearns proves that we’re now in the endgame of the collapse of the US financial system.  The Fed bailed out Bear Stearns because it had no choice.  There but for the grace of the financial gods goes every other financial house that played it fast and loose with subprime and derivative debt.  They all know that if the Fed hadn’t bailed out Bear Stearns, that the game was over.  Friday would have been the most disastrous day Wall Street would have ever seen.  It literally would have been the next Black Friday.

So the Fed acted.  It merely prolonged the inevitable, whisking the corpse of Bear Stearns away before anyone could get a good look at it, and it made the almost  unprecedented move of acting as Bear’s lender of last resort through JP Morgan…something that literally would take the unanimous vote of the entire Fed governors board to do.  And it was done in lightning fast fashion.

The fact the Fed acted in such precipitous fashion reveals the truth:  the US financial system is on its last legs.  The Fed does not know how to fix the problem, it only knows how to give band-aids and bailouts.  This was a “in case of emergency, break glass” moment.

Wall Street is both relieved and terrified.  They are relieved because the companies that are in real trouble know they will now be bailed out when they fail.  They are terrified because they know everyone was involved.  Bear Stearns is just the latest casualty.  There will be more.  Many more.

So why did the Fed do it?  Again, they had no choice.  Why?  Because the Derivative Armageddon would have come immediately if they hadn’t done so.  That $600 trillion dollar market would have crumbled, and even a partial loss, a percentage point, would be enough to sink the country.  It would have caused a cascading default that would have literally decapitated the global financial system.  Endgame.

So now we have to ask “What comes next?”  It’s difficult to say exactly, but the general theory is that Bear Stearns will not be alone.  More firms will expect bailouts when their insolvency crisis strikes.  More major firms will fall.

Eventually the Fed will have to go to the last step in can take:  socialization of these firms and their debt, in effect, throwing massive amounts of money at the problem.

In fact, that seems to be the plan.  But here’s the deal, the Fed has only so much money before it has to start literally pulling it out of thin air.  When that happens, inflation will skyrocket.  Other countries will take their investments elsewhere, and then the real pain begins, the pain of deflation.

There’s really nothing the Fed can do.  They can either inflate or raise rates.  Either one fails to address the problem.  The Fed’s gone for inflation as the less painful road.  Short term that may be true.  Long term it was a bad call.  We’ll be second guessing Helicopter Ben for years, but it was politically expedient.

The next President?  By the time they are allowed to actually do anything about this mess, it will be too late.  Bear Stearns will not be the last house to go under.

When enough people come to the realization that the Fed can’t do anything to solve the problem and that Bush and friends are trying to get out of the blast zone with as much loot as possible, the stampede for the exits will be legendary.

Watch to see if Congress tries to raise the debt ceiling anytime soon, that will be the dead giveaway, if you’ll excuse the pun.  Will we make it to 2009?  Right now, I’m not sure.

Be prepared.

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