Investors Brace for Wild Ride in Financial Markets

Financial markets want a rate cut to contain damage and keep markets moving in an orderly fashion. Investors were not soothed by the Federal Reserve pouring money into the economy to try to stave off a credit crunch.

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STEVE INSKEEP, host:

If you think you know what the financial markets will do this week, you've got something on the rest of us. The last couple of weeks have seen sharp drops in stocks. And last week, the Federal Reserve had to pump billions of dollars into the banking system. It all has to do with the availability of credit.

NPR's Jim Zarroli is tracking what we do know about the week to come. And Jim, granted that we don't know what's going to happen, what are some factors that are on the table here?

JIM ZARROLI: Well, there's a big report on the consumer price index, which comes out on Wednesday. That's going to be very closely watched because if prices are going up, the Federal Reserve is going to be less likely to cut interest rates. The markets really want a rate cut right now. They think it will contain some of the damage that we're seeing. Beyond that, I think it's a safe bet there's going to be more volatility.

The problem in the financial markets right now is that everything is changing really fast and no one knows what to expect. We know some mortgage lenders and hedge funds are in deep trouble. We know there have been losses. We don't know how deep the losses go or who's really at risk.

INSKEEP: You said people want an interest rate cut. Let's talk that through. That's because, all of a sudden, mortgages are becoming more expensive, businesses are having more trouble in having to pay more to borrow, and so an overall interest rate cut might be helpful to them?

ZARROLI: I think the financial markets want a rate cut because they think it will sort of contain the damage. It will help all the banks, all the hedge funds, everybody that is under the gun right now. It'll give them a little bit of breathing room and help them sort out what their investments are, what they owe, and in general keep the markets moving in an orderly way.

INSKEEP: Well, let's talk a little bit about hedge funds, which have been in a lot of trouble, these rather exotic investment vehicles. What part have they played in all this?

ZARROLI: Well, hedge funds these days are everywhere. A lot of pension funds and private endowments invest in them, but they tend to be pretty secretive about how they invest their money, so you get a lot of rumors and some - a lot of nasty surprises.

Last week, for instance, there were a lot of rumors about quant funds. That's short for quantitative. These are hedge funds that decide how to trade based on really sophisticated computer models. They're supposed to be set up so that they profit if the market goes down, they profit if it goes up.

Well, some of these funds did really badly last week, and The Wall Street Journal had a story about this this weekend that said some of the funds started behaving in a way that the computer models hadn't predicted. In fact, they were behaving exactly the opposite of how they were supposed to behave. So some of the funds started selling assets, that just exacerbated things, and you had a really bad few days. And the point is no one really expected that. No one saw that coming.

INSKEEP: Did you have situations where the computers themselves were ordering buying or selling of stocks in ways that made the markets even worse without even a human being involved?

ZARROLI: I think quant funds are set up in a way that the computer models decide what the trading positions are going to be, decide what the fund is going to buy, what it's going to sell, just in general what it's going to do. I think the managers can override that, but they tend to look at the computer models very closely and let that determine what they're going to do.

INSKEEP: So people are talking about these hedge funds, they're talking about interest rates hoping the Federal Reserve will lower them. Last week, the Federal Reserve actually poured more money into the economy. Could that happen again this week?

ZARROLI: It could. What happens in this kind of environment is something like this. You see people losing money, so they go to their hedge fund or their bank or whatever and they say, we want to cash in our assets. Well, the banks and the hedge funds don't have the cash there because they've invested it, they've invested it, you know, in real estate investment trusts or corporate bonds. And they can't get it either, because those funds and those investment trusts or companies they've all invested their money, too.

So the pipeline gets clogged. Well, the central banks can rush in. They can make money available so the whole system stays liquid, the funds keep moving. It doesn't mean that people aren't going to lose money, because they surely are, but it does stop the system from kind of seizing up, which really could cause a panic. All the central banks have a lot of reserves to do this, and they do it when they need to. They did it last week.

INSKEEP: Okay. So we don't know what's going to happen, but we know some factors involved. NPR's Jim Zarroli has brought them to us. Jim, thanks very much.

ZARROLI: You're welcome.

INSKEEP: You're listening to MORNING EDITION from NPR News.

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