As part of the deal, J.P. Morgan Chase, a major Wall Street bank, will buy Bear Stearns for a bargain-basement price, paying $2 a share for an institution that still plays a central role in executing financial transactions. Bear Stearns stock closed at $57 on Thursday and $30 on Friday. J.P. Morgan was unwilling to assume the risk of many of Bear Stearns’s mortgage and other complicated assets, so the Federal Reserve agreed to take on the risk of about $30 billion worth of those investments.

The Fed “is working to promote liquid, well-functioning financial markets, which are essential for economic growth,” Chairman Ben S. Bernanke said in a conference call with reporters last night. Treasury Secretary Henry M. Paulson Jr., who was deeply involved in the talks though not a formal party to them, indicated support for the actions.

The Fed’s moves were meant to reverse a rising tide of panic that has buffeted Wall Street as banks and other institutions have found it increasingly difficult to get credit.

At least twenty-seven states, including several of the nation’s largest, face budget shortfalls in fiscal year 2009. Of these 27 states, specific estimates are available for 22 states and the District of Columbia; the combined deficits of these 22 states plus the District of Columbia are expected to total at least $39 billion for fiscal 2009 — which begins July 2008 in most states. Another 3 states expect budget problems in fiscal year 2010, although some of those gaps may occur earlier than expected.

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The 22 states in which revenues are expected to fall short of the amount needed to support current services in fiscal year 2009 are Alabama, Arizona, California, Florida, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nevada, New Hampshire, New Jersey, New York, Ohio, Oklahoma, Rhode Island, South Carolina, Vermont, Virginia, and Wisconsin. In addition, the District of Columbia is expecting a shortfall in fiscal year 2009. The budget gaps total $39.1 to $40.8 billion, averaging 8.9 – 9.3 percent of these states’ general fund budgets.

In states facing budget gaps, the consequences could be severe — for residents as well as the economy.  Unlike the federal government, states cannot run deficits when the economy turns down; they must cut expenditures, raise taxes, or draw down reserve funds to balance their budgets.  Even if the economy does not fall into a recession as it did in the earlier part of this decade, actions will have to be taken to close the budget gaps states are now identifying.  The experience of the last recession is instructive as to what kinds of actions states may take.

• Cuts in services like health and education.  In the last recession, some 34 states cut eligibility for public health programs, causing well over 1 million people to lose health coverage, and at least 23 states cut eligibility for child care subsidies or otherwise limited access to child care.  In addition, 34 states cut real per-pupil aid to school districts for K-12 education between 2002 and 2004, resulting in higher fees for textbooks and courses, shorter school days, fewer personnel, and reduced transportation.
• Tax increases. Tax increases may be needed to prevent the types of service cuts described above. However, the taxes states often raise during economic downturns are regressive — that is, they fall most heavily on lower-income residents.
• Cuts in local services or increases in local taxes. While the property tax is usually the most stable revenue source during an economic downturn, that is not the case now. If property tax revenues decline because of the bursting of the housing bubble, localities and schools will either have to get more aid from the state — a difficult proposition when states themselves are running deficits — or reduce expenditures on schools, public safety, and other services.