Stock Market Settles Down After Another Sharp Sell-Off

By David Cho and Tomoeh Murakami Tse
Washington Post Staff Writers
Friday, March 2, 2007

Stock prices on Wall Street made a jittery recovery yesterday from a steep early morning fall that sent the Dow Jones industrial average plummeting more than 200 points.

The Dow closed down 34.29 points, or 0.3 percent, to 12,234.34. But the market's bungee jump, in which it plunged deep into the red just after the opening bell, recovered into positive territory and then fell again, was a sign of the anxious mood on Wall Street.

Many analysts said the wild week of trading, which included a 416-point drop by the Dow on Tuesday and a modest upswing Wednesday, could alter the economic landscape. Going forward, there simply may not be the same tolerance for risk, a shift that would have huge consequences for the United States and economies around the world.

Trading worldwide was generally grim yesterday. East Asia's largest markets dropped, with a key exchange in China falling nearly 3 percent. Europe's main indexes were down almost 2 percent before trimming losses.

"There certainly is a lot more fear in the market, there's no doubt about that," said Steven R. Howard, a partner at Thacher, Proffitt & Wood, a financial advisory firm. "The markets are much more volatile in terms of where emerging countries are going right now."

For years, because it was easy to borrow money, investors were able to make high-risk investments in the developing world and lend mortgages to credit-challenged home buyers in the United States. Private-equity firms were able to borrow tens of billions of dollars to buy out big companies.

Such borrowing and investing may have reached a turning point, some analysts said. For individual investors, that could mean smaller profits from their portfolios or difficulty obtaining a mortgage with poor credit. Globally, it could mean tighter business loans for companies as well as new struggles for promising economies such as Thailand, Indonesia, the Philippines and developing countries in Latin America.

Signs of a reversal in the availability of what is called "cheap debt" emerged this week.

One warning of this was when the Japanese yen yesterday hit an 11-week high against the dollar. That followed a 2.3 percent ascent -- a huge climb for a currency on a single day -- on Tuesday as stock markets around the world were plunging.

The connection between the markets and the value of the yen lies in what is known as the "carry trade." The term refers to investors who borrow money in Japan because it has one of the lowest interest rates in the world and invest the funds elsewhere. Often they invest in emerging markets or buy U.S. Treasurys that pay higher interest rates.

A little math may help explain the concept: If traders borrow 1,000 yen from a Japanese bank, convert the funds into U.S. dollars and buy bonds for the equivalent amount, they would profit off the difference in interest rates. So if the U.S. bond pays 5.25 percent in interest, and the traders only have to pay 0.5 percent in Japan, they would stand to make a profit of 4.75 percent, as long as the exchange rate between the countries does not change.

No one knows how large the carry trade is, but estimates have ranged as high as $1 trillion. Economists say this trade has been a major factor in keeping borrowing rates in the United States low because it has increased the purchase of bonds and notes in the United States This, in turn, keeps interest rates on the bonds low.

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