NEW YORK (Reuters) - A fire sale of Bear Stearns Cos Inc stunned Wall Street and pummeled global financial stocks on the eve of an expected U.S. interest rate cut aimed at preventing a meltdown of the financial system.

On a day marked by gut-wrenching drops of financial shares such as Lehman Brothers, U.S. stocks almost ventured into bear market territory -- a drop of 20 percent from the October high.

The market staged a late partial recovery as optimism set in over an expected decision by the U.S. Federal Reserve to slash rates by as much as 1 percentage point on Tuesday to jump-start financial markets and prevent a recession. The cut would be the latest in a series that has brought down borrowing costs but hammered the U.S. dollar to record lows.

“They have spent some bullets. The Fed has a lot more bullets than we’ve seen so far,” said Brian Edmonds, managing director of fixed income at Cantor Fitzgerald in New York.

Things looked bleak on Monday morning.

Staff at Bear Stearns’ Manhattan headquarters were welcomed to work by a two-dollar bill stuck to the revolving doors -- a spoof on the rock-bottom price of $2 a share that JPMorgan Chase is paying for the firm. A hopeful Coldwell Banker real estate agent was hawking cheap apartments to employees who saw the value of their stock options go up in smoke.

The combination of Bear’s swift bailout and the Fed’s offer on Sunday to extend direct lending to securities firms for the first time since the Great Depression highlighted just how hard the credit crisis has hit Wall Street.

And it scared market players worldwide.

“If you get a crisis of confidence in the wholesale banking space and something the size of Bear Stearns could go under, then people start to panic. You get a real fear factor,” said Simon Maughan, analyst at MF Global in London.

The grim mood spread. Investors bailed from rival Lehman for fear it would be next to face a cash crunch. Lehman shares plummeted 48 percent to a nearly 8-year low but partly recovered to close down 19 percent.

JPMorgan shares, by contrast, jumped 10 percent after the bank set a deal to buy Bear for $236 million, or a little over $2 a share -- a fraction of its 2007 high of $172.61. JPMorgan chief Jamie Dimon, a details-oriented Wall Street luminary with a track record of fixing up banks, also got the Fed to agree to guarantee up to $30 billion of Bear’s hard-to-value assets.

“When you get the most severely damaged collateral and cover yourself to the tune of $30 billion, that cushion goes a long way,” explained Bill Fitzpatrick, an analyst at Optique Capital, which owns shares of JPMorgan.

CONNECTIVITY - NOT ALWAYS A GOOD THING

Starting with packaging and reselling loans to U.S. borrowers with spotty credit, Wall Street’s financial engineering led to a global boom in complex debt instruments that are now very tough to value.

Markets for these securities have dried up and caused multibillion-dollar losses at banks worldwide -- from the biggest names in banking to regional German banks few had ever heard of before disaster struck.

The financial world is more interconnected than ever and the merest whiff of trouble can result in an old-fashioned bank run: traders and funds pulling out money and calling in loans.

Bear’s demise shows how fast things can change on Wall Street. Less than a week ago, the firm’s stock was trading at more than $60 a share and its chief insisted it was in good shape. On Monday afternoon, phones at Bear’s trading floor were dead.

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Bankers around the world were already fretting about job losses because of the endless series of credit losses. It could get worse: The mayhem could spill over to Main Street, already reeling from a housing crisis.

That’s why policymakers are pulling out all the stops, from cutting interest rates to flooding the financial system with cash to prevent it from seizing up. Fed Chairman Ben Bernanke, a student of the Depression, is now using tools the Fed hasn’t touched since the 1930s.

Trying to assuage worries that the credit crisis is spinning out of control, President George W. Bush said the United States was “on top of the situation.”

Bush, who came under fire for lack of leadership by Democratic presidential contender Hillary Clinton, later met with top financial regulators, including U.S. Treasury Secretary Henry Paulson and Bernanke. Paulson defended the government-sponsored Bear Stearns rescue as a better option than letting it go bust.

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Government funds from the booming Gulf and Asia-Pacific regions have pitched in by buying stakes in big-name banks such as Citi and brokerages such as Merrill Lynch.

This time around, though, the sovereign wealth funds were conspicuously absent -- spelling trouble ahead.

“There’s no way anybody’s going to catch a falling knife. Why come in now?” said Craig Russell, Beijing-based chief market strategist at Saxo Bank.

The problem is that banks need the cash to shore up their balance sheets. So shares of European banks -- including UBS in Switzerland, HBOS in Britain and SocGen in France -- fell more than 10 percent on concerns they have to take bigger hits -- haircuts, in Wall Street speak -- on their holdings of credit assets.

IN MOURNING

The sale of Bear was a rude awakening to the 85-year-old firm’s 14,000 staff, who own roughly 30 percent of the company. Overnight, fat options packages turned worthless and job security vanished.

“The valuation is virtually nothing,” said a Singapore-based Bear Stearns employee. “It is indeed rock bottom. We have tanked. It’s very, very sad. Everyone is in mourning.”

The mood among U.S. staff was similarly solemn, with financial TV network CNBC reporting that JPMorgan is looking to cut half of the Bear work force.

“I’ve been at Bear for 11 years and I want to vomit,” said a Bear Stearns employee who described himself as a partner.

A lot of people lost a lot of money. At a neighborhood party in New Jersey over the weekend, a Bear Stearns office plodder told a longtime stock broker colleague at the firm who lost $9 million in wealth: “You lost a lot more than I did. You’re a big fish.”

And then there is English entrepreneur Joe Lewis, a high-stakes currency trader who bought a stake of about 10 percent in Bear and about $1 billion in the hole. He called the JPMorgan’s offer “derisory.”

Lewis himself is now seen as damaged goods. Futures brokerage MF Global assured the market that Lewis was not on its client roster as investors pushed down its shares as much as 78 percent for fear Bear’s collapse might spill over.

Any crisis brings opportunities, though. Phones were ringing off the hook at law firms that specialize in suing corporations whose stock has plummeted.

“Shareholders don’t contact me when they are happy with the way things are going with their investments,” said Ira Press, a lawyer at class-action firm Kirby McInerney.