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John Hersey

Hedge funds, already suffering from an ill-fated love affair with leverage, are finding themselves haunted by another problem. It turns out many so-called funds of hedge funds, portfolios with stakes in multiple hedge funds, also depended on borrowed money. Now, with lenders retracting credit, fund-of-funds managers are being forced to dump assets, putting further pressure on the hedge funds and the markets generally. It's "a vicious circle," says Kate Hollis, director of fund research at Standard & Poor's (MHP).

As the great edifice of leverage crumbles, funds of funds are faring worse than hedge funds. They're off 18.7% this year, vs. 15.5% for individual hedge funds. Among the funds of funds hit hard: some run by Fix Asset Management, Ontario Partners, and HRJ Capital, co-founded by former football star Ronnie Lott. All declined to comment for this story.

Funds of funds were supposed to be the safer choice for high-net-worth individuals and big institutions. By spreading their bets across dozens of investments, managers assured clients they didn't have to worry about a blowup in any single portfolio. It was the sort of flawed diversification argument used to justify many speculative investments during the boom, including those notorious collateralized debt obligations stuffed with subprime mortgage securities. The pitch fueled explosive growth: By the end of 2007, funds of funds accounted for 43%, or $747 billion, of the hedge fund industry, up from 19%, or $103 billion, in 2001, according to Hedge Fund Research.

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Roughly half of that universe employed leverage. Some funds of funds borrowed directly from banks to buy $2 of assets for every $1 of investors' money. Brokers, meanwhile, encouraged wealthy customers to finance their fund-of-funds purchases on credit. Big banks sold "principal protection products," derivatives that supposedly guaranteed clients wouldn't lose a cent of their initial investment—and the banks in effect used leverage to create those insurance policies.

The funds of funds were layering leverage upon leverage. They owned hedge funds already loaded up with debt, roughly $6 for each $1 of capital. When credit seized up, the process began to reverse. "Once things start to delever, everything contracts," says Andrea S. Kramer, a lawyer at McDermott Will & Emery who represents hedge funds.

To protect themselves, such big global banks as France's BNP Paribas, KBC Group of Belgium, and the Royal Bank of Canada are now charging higher fees on loans they extended to funds of funds, or pulling the loans entirely. The tight credit is compelling fund-of-funds managers to sell their holdings, which is driving individual funds to dump stocks, bonds, and commodities.

The situation shows no sign of stabilizing. Consider CMA Global Hedge PCC, a $360 million fund of funds. The portfolio, which over the years used financing from JPMorgan Chase (JPM), Société Générale, and HSBC (HBC), is currently relying on credit from Citigroup (C) . Its holdings—47 hedge funds—are down 11%. Add in leverage, which amplifies losses, and CMA Global is off 25%.

Wary of Citi charging more for the fund's loan, manager Sabby Mionis is trying to sell hedge fund stakes to reduce debt. But a number of the funds have suspended redemptions, making it tough. Mionis is now working on a plan to return some money to investors: "For the foreseeable future, leveraged funds of funds are dead."

Department-store operator J.C. Penney Co. said Friday its third-quarter profit fell by more than half as consumers cut back on spending and took fewer trips to the mall amid the deteriorating economy.

The company also said mall traffic in general has been weak so far this month and issued fourth-quarter guidance well below analyst expectations.

J.C. Penney shares fell $1.60, or 8.3 percent, to $17.68 during midday trading, nearing its 52-week low of $16.39. In February, the stock had traded at a year-high of $51.42.

Department stores, including mid-tier J.C. Penney, have been among the retailers hardest hit by consumers' cutbacks and bargain hunting amid an economic slowdown, shaky job market and prolonged housing slump. On Friday the Commerce Department reported that retail sales plunged by the largest amount on record in October as consumers cut back on spending in the wake of the financial crisis.

The company said profit for the three months ended Nov. 1 fell 52 percent to $124 million, or 56 cents per share, from $261 million, or $1.17 per share, last year. Revenue slid 9 percent to $4.32 billion from $4.73 billion last year.

Analysts surveyed by Thomson Reuters expected a profit of 53 cents per share on slightly higher revenue of $4.39 billion.

"As sales have been impacted by lower consumer spending and declining mall traffic, we have been effective in reducing selling, general and administrative expenses without compromising our customer experience and in managing our inventories to appropriate levels," Ullman said in a statement.

Sales in stores open at least one year fell 10.1 percent. Women's and children's apparel and family shoes were the best performers while jewelry and home divisions continued to be weak. Sales held up best in the Northeast and Central regions, but were offset by weak results in the Southeast and Southwest, where the housing slump has been the most pronounced.

Looking ahead, Ullman said he expects the weak environment will persist "well into 2009" and is planning business accordingly.

Heading into the holiday season, Plano, Texas-based J.C. Penney plans to woo customers into its stores by ramping up its gift assortment and customer service and launching a marketing campaign aimed at conveying both the style and value of its products.

"Our marketing shows our customers we understand their financial pressures," said Chairman and Chief Executive Myron E. Ullman III said in a conference call with investors.

The company is also "aggressively" targeting customers of the 177 stores that Mervyns has closed or is closing under its bankruptcy-protection plan in an effort to convert those shoppers to J.C. Penney.

But the company expects fourth-quarter earnings will range between 90 cents and $1.05 per share, far below the $1.32 per share analysts are predicting, on a 7 percent to 9 percent sales decline. J.C. Penney expects same-store sales to fall 9 percent to 11 percent in the fourth quarter.

The company also said it will record a hefty charge in fiscal 2009 related to an accounting method it uses for its pension plan, but will not know the actual value of the charge until the end of the fiscal year.

Stocks were trading lower Friday after Thursday's big rebound, as dismal retail sales figures forcing investors to focus on the economy. Signs of disunity in the government's response to the financial crisis also weighed on equities.

Federal Reserve Chairman Benjamin Bernanke, speaking at the ECB's Frankfurt Central Bank conference, prior to the G20 economic summit in Washington, said that central banks are in close contact and ready to take additional action if necessary, while liquidity measures have led to "tentative improvements" in credit markets. Bush says this will be first of series of meetings to deal with the global financial crisis.

On Friday around 11:30 am ET, the Dow Jones Industrial Average fell 279.72 points, or 3.17%, to 8,555.53. The broad S&P 500 index shed 32.58 points, or 3.58%, to trade at 878.71. And the tech-heavy Nasdaq composite dropped 68.81 points, or 4.31%, to 1,528.03.

On the New York Stock Exchange, 24 stocks were trading lower for every four posting gains, while on the Nasdaq the ratio was 19-5 negative amid moderate trading.

In economic news, October retail sales fell record 2.8%. Excluding autos, building materials and gasoline (the components of the report that feeds into the calculation of nonauto goods consumer spending within GDP), retail sales fell 0.5% in October.

Even after adjusting for price-related drops in gas station sales, this report suggests that consumer spending started the fourth quarter on a very weak note. RDQ Economics estimated that real personal consumption expenditures fell by 0.4% in October and will decline by at least 3%, and possibly more than 4%, for the entire fourth quarter. Much will hinge on the November release of retail sales in fine-tuning the GDP estimate for the fourth quarter, RDQ Economics said in an email note.

Import prices fell 4.7% -- exceeding the 4.4% downturn that was widely expected.

U.S. business inventories fell 0.2% in September and included a 0.2% decline in retail inventories with a 0.3% drop for vehicle inventories, but stronger than expected figures for the remaining components. Inventories had been expected to rise.

The University of Michigan Consumer Sentiment Survey showed an increase in the preliminary reading to 57.9 in November, better than the expected 55.0 after October's 57.6 reading.

U.S. FDIC unveiled a mortgage modification plan aimed at 2.2 million home loans, with incentives for mortgage servicers to modify loans and reset affordable monthly payments. The plan is projected to cost $24.4 billion to the government and potentially prevent some 1.5 million foreclosures, with servicers paid $1,000 toward modification expenses and the FDIC to share up to half the losses in the event of default. The FDIC would manage the plan on the behalf of the Treasury and it appears funding would come from the TARP. The Treasury Dept. is so far not supporting the plan.

Uncertainty surrounds the financial rescue package known as Troubled Asset Relief Program, or TARP. On Tuesday, Treasury Secretary Henry Paulson switched gears by announcing that TARP funds would not be used to purchase illiquid mortgage-related assets from financial institutions. Two months ago, Paulson said TARP would act as a clearinghouse for toxic credit assets such as mortgage-backed securities. Instead, Paulson said those funds will continue to be used to buy shares in banks. The painful downside is that the TARP switcheroo has made matters worse for banks that held assets waiting for a TARP rescue and now must sell them in a far worse market and economy than two months ago, according to the Wall Street Journal. Today is the deadline for banks to apply for cash from the $700 billion TARP plan.

Paulson's latest TARP flip-flop has hammered asset-backed securities, reports the Wall Street Journal. Markit's ABX index of 2006-vintage, triple-A-rated subprime-mortgage securities has fallen 13% since Wednesday to a record low. The cost of default protection on commercial-mortgage debt has jumped to a record high.

DETROIT -

General Motors' October U.S. sales plunged 45 percent and Ford's dropped 30 percent, as low consumer confidence and tight credit combined to scare customers away from showrooms.

The results released Monday - along with a 23 percent drop at Toyota (nyse: TM - news - people ) and a 25 percent decline at Honda (nyse: HMC - news - people ) - are strong indications that sales for the industry as a whole may perhaps be the worst in 25 years.

Detroit-based General Motors Corp. (nyse: GM - news - people ) said its light trucks sales tumbled 51 percent compared with the same month last year, while demand for passenger cars fell 34 percent.

The results were less severe at Ford Motor Co. (nyse: F - news - people ), which said its Ford, Lincoln and Mercury car sales were off 27 percent, while light truck sales for the three brands were down more than 30 percent.

Overall, GM sold 168,719 vehicles, down from 307,408 in the same month last year, while Ford, including its Volvo brand, sold 132,278 light vehicles last month down from 189,515 in the same month last year.

Mike DiGiovanni, GM's executive director of global market and industry analysis, said the credit crisis and financial market turmoil are affecting the industry to a "frightening" level.

If GM's sales were adjusted for population growth, October would be the worst month of the post-World War II era, he said.

"Clearly we're in a very dire situation," he said.

Despite the steep drop, GM's total was enough to keep it ahead of Toyota Motor Corp. for the No. 1 U.S. sales spot. Toyota sold 152,101 vehicles, down from 197,592 in October 2007. The drop included a 34 percent decline in light truck demand, while car sales fell 15 percent.

Honda Motor Co. sold 85,864 vehicles as its truck sales fell 29 percent. But sales of cars from its Acura luxury division rose 6 percent.

Ford officials said on a conference call with reporters and industry analysts that as bad as October sales were, it's probably not the bottom.

Emily Kolinski Morris, the company's senior economist, said that because automobiles are more durable, people can wait without buying a new vehicle until they feel more confident in the economy.

"The answer to when we will start to come out of that trough lies in when the economy comes out of that trough," Kolinski Morris said.

Poor sales in the last three months are expected to equal dismal third-quarter earnings for the struggling automaker. Ford is scheduled to release its financial results Friday, and the down sales raise the possibility of further plant closures or shift cuts. Ford has said it will continue to reduce production to match consumer demand.

Sales of the company's F-Series pickup trucks, traditionally its top seller, fell 16 percent in October. The company began selling a new version of the pickup last month and has announced plans to add 1,000 workers at its Dearborn Truck Plant in January to handle what it expects will be increased demand.

Some industry analysts are predicting a seasonally adjusted annual sales rate in October of 10.8 million or less, down from 16.1 million a year ago. If the rate drops below 10.83 million, it would be the worst sales month since March 1983, according to Ward's AutoInfoBank. The closely watched figure indicates what sales would be if they remained at their current rate all year, with adjustments for seasonal fluctuations.

After reeling from a 32 percent drop in September sales, Toyota launched zero-percent financing on almost all of its models prompting analysts to speculate that it could post better-than-average sales as a result.

But, like at Ford, the vast majority of Toyota models still posted double-digit declines. Notable exceptions included sales of the Corolla, which rose 6.1 percent, and the Sequoia sport utility vehicle, which posted a 21 percent gain.

Meanwhile, GM's financing arm, GMAC (nyse: GJM - news - people ) Financial Services, said it was tightening its lending standards to require a credit score of at least 700, potentially shutting out some buyers.

Analysts said GM's employee pricing incentives in September could have pulled in buyers who would have waited to purchase cars, further reducing GM's October sales.

The Associated Press reports unadjusted auto sales figures, calculating the percentage change in the total number of vehicles sold in one month compared with the same month a year earlier. Some automakers report percentages adjusted for sales days. There were 23 sales days last month, two less than in October 2007.

AP Auto Writer Bree Fowler reported from New York.

TOKYO, Oct. 22 -- Global stocks fell sharply on Wednesday as fears of a worldwide recession elbowed its way into Asian and European markets.

With signs that the worst of the credit crisis is easing, weak corporate earnings, rising inventories and falling demand are now in focus from Wall Street to Tokyo.

Stocks in Japan declined nearly 7 percent, while an index of equity shares across Asia fell more than 5 percent -- at one point hitting a four-year low.

South Korean shares hit a three-year low and the country's troubled currency, the won, fell again against the dollar. A $130 billion plan by the Seoul government to strengthen the won, stabilize stocks and restore bank liquidity was announced last weekend, but it has failed, so far, to overcome concern that a global recession will drag down South Korea's export-dependent economy.

European indexes opened lower and headed down further through the day. By early afternoon, major exchanges in the U.K., France and Germany were down in excess of 3.5 percent.

Bank of England head Mervyn King had warned in a Tuesday speech about a possible "sharp and prolonged slowdown," and signaled possible future interest rate reductions.

The likelihood of continent-wide interest rate cuts has helped push the Euro and the pound down sharply against the dollar, with the Euro dipping below $1.30. Crude oil continued its decline, falling below $70 a barrel.

Futures pointed to triple-digit losses when trading on Wall Street opens.

In a sign of an evolving economic slowdown, exporters in Asia are seeing an alarming rise in inventories as demand from the United States and Europe declines, analysts said.

In Japan, major exporters like Toyota, Sony and NEC Electronics are being squeezed between the soaring value of the yen, which makes Japanese goods more expensive, and the eroding willingness of anxious American and European consumers to keep on buying.

Japan's benchmark Nikkei stock index fell 6.8 percent on Wednesday, ending three days of gains. The broader Topix index slumped 7.1 percent.

Symbol Lookup: Companies & Funds

LONDON, September 16, 2008

By Sarah Mower

It takes a unique mind to watch Planet of the Apes and use it to start a fashion collection, but that's where Christopher Kane jumped off for Spring. He liked the apes' leather tunics. "It was that, and then The Flintstones, Raquel Welch in One Million Years B.C., and then Dian Fossey and her gorillas," he said. And, like all little boys, Kane loved playing with toy dinosaurs. Hence, the stegosaurus shoes.

Even his sister Tammy was incredulous at first. "When he started saying 'prehistoric,' I said, 'What? I don't know what you're talking about.'" But then the pair started work, and what emerged was an obsession with scales, which somehow morphed into half-circle 3-D geometric cutting in organza or leather, and even a bit of menswear fabric. Then he worked in bright animal-spot "Flintstone" cashmeres (made at Johnstons in Kane's native Scotland), photo-prints of Digit the gorilla, and finally, some suggestive marabou trimming on chiffon—a late thought about Peter Bogdanovich's Voyage to the Planet of Prehistoric Women for that special borderline-tacky touch that always puts the finishing stamp on a Christopher Kane collection.

Overall, it was a deft move forward for a young designer who needs to cement an identity and prove something more than an ability to come up with a novel idea each season. The circle cutting, which held echoes of Cardin or Capucci, looked young and modern—and provided a direct link to the giant paillettes Kane used last season. When the scallops stood out to frame a shoulder line or run up and down a pair of skinny pants, they looked head-turningly new, though when they turned into conceptual bundles, the wonder wore off. The sweaters continued his signature in a bright, accessible way, and the gorilla prints, though patched into two structured cotton dresses on the runway, will also be available as easy-to-wear and well-priced T-shirt dresses. Kane's still a designer who can hit fashion sideways with a new idea, but there are signs that he's beginning to think of how to turn what he has into a brand.