Market Volatility Shuts Two Hedge Funds

Highland Capital has said it is shutting down two hedge funds amid what it called unprecedented market volatility. In a day of major fluctuations, the Dow has jumped more than 400 points. The rise can be attributed to bargain hunters.

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MELISSA BLOCK, host:

From NPR News this is All Things Considered. I'm Melissa Block.

MICHELE NORRIS, host:

And I'm Michele Norris. First this hour, the economy. In a moment, we'll hear about the impact of the financial crisis on a city in Ohio, but we begin with Wall Street and the hedge fund industry. The Dow jumped about 400 points today after a stinging loss yesterday. But this week, the havoc in the markets claimed two more casualties. Highland Capital said it was shutting down two hedge funds because of what it called unprecedented market volatility. NPR's Jim Zarroli joins me now. And first of all, Jim, the market seemed to be all over the place over the course of the day. What should we make of the close?

JIM ZARROLI: Well, you know, this is the kind of thing that often happens after you've had big declines in the market. People come back and snatch up bargain stocks. And that seems to be the best explanation for what happened today. It really happened late in the day. It's not totally clear what direction the market is going in right now.

NORRIS: If we could move on to the hedge funds, they have been one of the fastest growing parts of the financial sector. It sounds like they're not doing so well right now though.

ZARROLI: Yeah, I mean, it's not easy to get information about hedge funds because they really aren't regulated. But there are companies that try to ferret this stuff out. One of them is TrimTabs. And it says that in September, investors took $43 billion out of hedge funds. Here's analyst Conrad Gann.

Mr. CONRAD GANN (Chief Operating Officer, TrimTabs): There are a number of prominent firms that are down 20, 25 percent. We looked at one list and we saw 39 name-brand, large mega-billion-dollar funds, all of which lost 10 percent or more in September.

ZARROLI: And Gann says that's just September. October is probably worse because, you know, stocks have fallen so much this month.

NORRIS: What are hedge funds doing in response to the downturn in the market? Are they somewhat more protected?

ZARROLI: Well, you know, the problem is that they are highly leveraged. In other words, somewhere along the line, they took their assets and borrowed against them so they could invest even more, just a way of maximizing their profits. So now they have to pay back what they owe. The only thing they can do is sell stuff off. And some analysts will tell you this is a big reason why the markets have fallen so much lately. We've just had a huge wave of selling by all institutional investors, but especially by hedge funds.

NORRIS: Quickly before we let you go, is Highland Capital perhaps a bellwether? Are we likely to see more hedge funds go under?

ZARROLI: Well, there's no question it's already happening. On the other hand, you know, hedge funds have certain things in their favor. They have a certain latitude about how they invest their money. One of the things that's happening right now is that hedge funds have sold off assets and are just keeping the money around as cash on their balance sheets. And they're kind of waiting on the sidelines for a chance to reinvest it. So when the stock market finally does begin to recover, you'll see this rush of hedge fund money back into stocks. But for now, a lot of them are just waiting.

NORRIS: Thanks, Jim.

ZARROLI: You're welcome.

NORRIS: That's NPR's Jim Zarroli speaking to us from New York.

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Stocks Turn Higher As Market Assesses Economy

Wall Street remained tense Thursday, swinging between sharp gains and losses as investors examined mixed economic and earnings data for clues about the health of the economy. The Dow Jones industrials, down 380 at one point, closed up 401 points, at 8,979; the major indexes also saw broad gains.

It seems investors just aren't sure how to value stocks, so they are bidding them up and down without paying much attention to the fundamentals. And that's adding to the volatility.

The morning began with several negative economic reports, which contributed to growing fears that the U.S. is heading for a nasty recession. The Philadelphia Federal Reserve bank said its index of general business activity fell to a minus 37.5 from a positive 3.8 in September. That is the weakest level the index has been since 1990. A negative reading means the economy is contracting.

The Federal Reserve also reported that industrial production at the nation's factories, mines and utilities fell 2.8 percent last month — almost triple the drop economists had been forecasting. The Fed said two hurricanes in the Gulf Coast accounted for the lion's share of the decline. A shutdown at Boeing plants only added to the number's dive.

"People are scared, and when they are scared, they want to go to cash," John Mack, the chairman and CEO of Morgan Stanley, told CNBC this morning as he tried to explain why the stock market has been crashing.

When asked whether recession fears were driving the market down, Mack shook his head. He said that he thought the economy was already in recession and would continue to be in one for some time to come. The big problem, he said, was confidence.

Citigroup Loss Points To Grim Outlook

The economic numbers are likely to get worse before they get better. Analysts said frozen credit markets and skyrocketing borrowing costs are expected to take a bite out of the economy. Now earnings reports are going to be added to the picture, and they are expected to be grim.

Citigroup, one of the four big banks the government pledged billions of dollars to earlier this week, announced its third-quarter earnings Thursday. For the fourth straight quarter, it had to report a loss. The numbers were staggering. Citigroup had to write down more than $13 billion in risky debt. It has cut 11,000 jobs since June. The bank said it lost $2.8 billion, or 60 cents a share, in the third quarter. Last year at the same time, it was profitable. Citigroup's write-downs related to bad debt and souring mortgages have topped $51 billion so far.

Citigroup's announcement helped to reignite fears that bad news from banks is only just beginning to come to the surface. Just how much banks are in the red — how much toxic debt they are carrying on their books — is still a big unknown. It is unclear how various financial institutions will measure delinquencies and write-offs.

Morgan Stanley's Mack alluded to that during his CNBC interview. "What we need," he said, "is confidence in the system."

A Struggle To Inspire Confidence

The Treasury had been hoping to inspire that confidence when, earlier this week, it set in motion the largest government intervention in the American banking system since the Great Depression. On Tuesday, the Treasury said it would be injecting $250 billion into thousands of the nation's banks to convince the banks themselves that it was safe to start lending again. The program, which begins this week, is meant to be a straightforward way to beef up thinning bank reserves.

Many banks have been running on the cash equivalent of fumes during the financial crisis. Not only are they on the hook for their bad bets on mortgage-related investments; they are also having trouble getting money for their normal day-to-day operations because no one is sure about what lies on a bank's balance sheets. Banks that have money are loath to lend it out because they are worried they won't get it back — a mind-set that has frozen the world's credit markets.

Mack said he had seen some progress in the credit markets, though "not as much progress as the Treasury would like."

The three-month London Interbank Offered Rate, or LIBOR, dropped to 4.50 percent from Wednesday's 4.55 percent. But that is still pretty high. The one-month rate fell to 4.2775 percent from 4.35 percent. The overnight rate tumbled to 1.93 percent from 2.13 percent on Wednesday. That's moving it closer to the Fed's 1.5 percent target rate for short-term rates.

Mack said the $700 billion bailout program is starting to work, but the effects wouldn't be immediate. "We're beginning to work through it and there is a lot of focus on how to open the credit markets up again," he said, adding that none of this will be easy. "We're in for a rocky road for a while."

The last time the Treasury waded into the banking system in this way was in the 1930s. That's when the government set up the Reconstruction Finance Corp. to make loans and buy stakes in distressed banks during the Great Depression. The price tag at the time: $1.3 billion. The government eventually got out of the banking business when the economy stabilized. The government sold the stock it held to private investors and the banks themselves. That's expected to happen in this case as well.

The Associated Press contributed to this report.

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