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At first glance, third-quarter results from telecom giant AT&T (T) appear strong. The Dallas-based phone service provider posted net income of $3.23 billion, or 55¢ a share, a 5.5% increase from $3.06 billion, or 50¢ a share, a year earlier. Revenue gained 4%, to $31.3 billion, led by a notable 15.4% increase in wireless sales. To boot, the wireless business logged a whopping 2 million net new customers, giving AT&T nearly 75 million subscribers nationwide.

But troubling signals lie just beneath the surface. Customers are disconnecting phone lines at an alarming rate. Too few are signing on for broadband connections, and though the number of new wireless subscribers is impressive, AT&T's wireless margins are getting squeezed. All of this comes in the face of a weakening economic outlook that's forcing consumers to cut household budgets and banks to rein in lending. Worried shareholders traded AT&T stock down 7.6%, to about 23.78, after the results were released on Oct. 22. "The market is telling you there is a lot of risk out there for AT&T," says Timothy Horan, an analyst for Oppenheimer & Co.

And what's risky for AT&T may prove just as ominous for the rest of the telecom sector. Analysts expect Verizon Communications (VZ), Sprint (S), and other phone service providers to show similar signs of weakness when they report results in the coming days. In fact, AT&T is something of a proxy for the broader economy. As a huge provider of services to major businesses, AT&T's customer list contains businesses of every stripe. It is instructive that the carrier's enterprise services unit saw sales dip 1.4% from a year ago. "That is troubling as you head into the teeth of the recession," says Sanford C. Bernstein analyst Craig Moffett, who adds that the view of AT&T's financial future right now is "as clear as mud."

Existing strains in AT&T's local-phone business were accentuated in the third quarter. The number of consumer voice lines in service fell 10.5%, to 28.33 million, from a year ago. Things are not much better in the broadband arena. Last year at this time, AT&T added nearly 500,000 digital subscriber lines. This year, it added 148,000, a decline of more than 70%. "These are obviously challenging times," AT&T Chief Financial Officer Rick Lindner said on an Oct. 22 conference call with analysts.

The 10,000 hedge funds with more than $1.7 trillion in assets are caught in a vicious cycle. Worried investors are pulling out their money—some $31 billion through September, according to Hedge Fund Research. As part of the great deleveraging that's happening across the financial system, lenders are cutting credit lines or demanding that funds come up with more cash in what's known as a margin call. The cash squeeze is forcing hedge funds to dump holdings. "Redemptions and margin calls are exaggerating the market swings," says Timothy M. Ghriskey, co-founder of Solaris Asset Management, a $2 billion institutional fund.

Meanwhile, the Lehman Brothers bankruptcy is tying up tens of billions of dollars of hedge fund assets. Scores of money managers parked cash and other securities at the investment bank's prime brokerage operation in accounts that are now frozen. Other hedge funds had derivative deals with Lehman, complex financial transactions that could take months to unwind.

Stay of Execution?

None of those problems will clear up any time soon. It's difficult for funds that are down 30% or more to raise new money, persuade investors to stay, or retain top talent—a fatal combination that will make it impossible for many funds to stay open in this environment. The next critical deadline: Nov. 30, the final day of the year that many hedge fund investors can file to redeem their stakes. Unlike mutual funds, which trade daily, hedge fund customers can request their money only on certain dates, typically once a month or quarter.

Clients of firms with long-term records of strong returns may decide to give the funds a stay of execution even if losses are huge. That's one reason why some hedge fund managers are pleading with their customers to stick around. Citadel Investment Group CEO Ken Griffin apologized for two funds' near-30% drop since the start of the year, promising "to create value over the years to come." Ramius Capital, down 11%, is trying to keep investors from rushing for the exits by cutting expenses, an unheard-of move in this fee-hefty business.

Despite such efforts, the wreckage is likely to be significant. Charles Biderman, chief executive of TrimTabs Investment Research, estimates that 25% of hedge funds will be out of business by the end of 2009. "When [managers] are losing money for people, [they] are not getting pleasant phone calls," says Sol Waksman, founder of industry tracking service Barclay Hedge. "Some ask, 'why am I doing this?'"

The favorite holdings of hedge funds will keep bearing the brunt of the pain from the shakeout. A Goldman Sachs (GS) index that tracks the top stocks held by hedge funds dropped by 34% over the three weeks ending Oct. 10, a period when managers were frantically selling shares. The Standard & Poor's 500-stock index, by comparison, fell by 28%. Among the biggest losers: Apple (AAPL), off 31%, and Freeport-McMoRan Copper & Gold (FCX), down 51%.

Since some hedge fund managers are selling indiscriminately, even relatively good companies can get hurt. Consider MasterCard (MA). The stock dropped 33% over that same three-week period, even though revenues were up 25% last quarter. Why is that? Hedge funds, which own roughly a quarter of the credit-card company's stock, may be putting additional pressure on the shares. One major shareholder, hedge fund Atticus Capital, has lost nearly $5 billion, or 20% of assets, since the start of the year—a steep drop that fueled speculation in September that the fund wouldn't be around much longer. Manager Timothy R. Barakett has publicly denied the rumors, insisting Atticus is in the market for the long haul.

The U.S. government may start guaranteeing the mortgages of some homeowners who are heading for default, in hopes of convincing lenders to renegotiate the terms of troubled loans and avoid more foreclosures, Federal Deposit Insurance Corp. chairman Sheila C. Bair said today.

Bair told the Senate Banking Committee that the recently approved economic bailout package included authority for the Treasury Department to offer government loan guarantees and other incentives as a way to encourage banks and mortgage lenders "to prevent avoidable foreclosures."

There has been a "failure to effectively deal with" the mortgage foreclosure problem, Blair said.

The FDIC chairman has argued that the extensive set of financial rescue strategies deployed in recent weeks needs to do more to get at what she called the "root cause" of the crisis -- millions of households heading for default on their mortgages and potentially foreclosure on their homes.

Falling home values have been a key part of the dynamic. Some families took out loans with adjustable or low introductory rates, convinced that rising home values would let them refinance or sell before higher interest rates kicked in. When home values fell and credit markets froze, those same homeowners found themselves owing more on the property than it was worth, unable to refinance or cover their loan through a sale.

Bair said new efforts to stem foreclosure are needed, even if it means the Treasury offering to absorb losses on some soured mortgages.

"Loan guarantees could be used as an incentive for servicers to modify loans," Bair said. "Specifically, the government could establish standards for loan modifications and provide guarantees for loans meeting those standards."

Questioned by Sen. Chris Dodd (D-Conn.) as to whether the FDIC has the capacity to handle such a program, Blair said the Treasury Department would be in charge, and the FDIC would act as a contractor to help guarantee loans.

One big hurdle for private mortgage companies looking to restructure loans is that no industry-wide framework has been established to guide the process. "They've been doing it ad-hoc," Blair said.

Neel Kashkari, the interim head of the government's $700 billion rescue effort, said the Treasury Department is still in the "policy process" of figuring out how the program would work.

Bair said the program would be short-term, with federal assistance ending June 30. The temporary nature of the program, she said, is the key to preventing private banks from depending on federal help for all of loans.

Kashkari said the restructured loans would be handled by the banks themselves, but with "very specific instructions consistent with our objectives."

Although the program is first focusing on the residential housing market, there is a possibility it could be extended to the commercial real estate market as well, officials said.

Dodd emphasized a sense of urgency. "There are more than 10,000 foreclosures a day," he said. "I hope there's a deep appreciation that we need to get this moving."

Also today, RealtyTrac reported that U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier, reaching the highest on record. A total of 765,558 U.S. properties got a default notice, were warned of a pending auction or were foreclosed on in the quarter, the most since records began in January 2005.