Of all the reasons cited for the stock market's decline this year, few equity analysts have highlighted the impact of hedge funds.

Some observers say the funds, which have become increasingly influential in recent years, are having an effect on the fortunes of corporate America and may well be exacerbating the decline in stocks.

While some hedge funds have seen large losses in recent weeks amid a meltdown in the corporate bond market, others, who have bet that these bonds would go down, have been profiting nicely.

Some bond analysts believe that hedge funds are fueling the declines in both the corporate bond and equity markets. But analysts also point out that publicly traded companies have made themselves vulnerable by using questionable accounting or by being overleveraged and missing earnings estimates.

Vaporous VIX

"As much as we want to attribute the volatility to hedge funds, and that is true, it is not really the primary problem," said Bill Cunningham, a corporate bond analyst at Chase Securities. "The primary problem is the debt binge that we're still working off."

Throughout the late 1990s, companies issued vast amounts of debt to fund capital expenditures, and analysts say the market became saturated. Others say the stock market remains overvalued and is continuing to unwind the excesses of the last few years.

John Van, chief financial officer of Van Hedge Fund Advisors, said while hedge funds may be shorting corporate bonds, investment banks, commercial banks, pension funds and other institutional investors are doing exactly the same thing.

"Hedge funds, despite what people believe, just don't control that much of the world financial system," he said, adding that hedge funds have about $600 billion in assets under management worldwide, while pension funds control much more than that. "Is it their fault that they're shorting

WorldCom

(WCOME)

? Is that why it's going down? Is that why bondholders and shareholders are feeling some pain? No, it's because WorldCom let them down."

Get Shorty

In 2002, hedge funds that have engaged in any short-selling were up almost 15% through the end of May, according to Van Hedge Fund Advisors, while the overall stock market fell 7%. Through the end of June, hedge funds have fallen 0.4% for the year compared with a decline of almost 14% for the

S&P 500

.

Although hedge funds tend to keep their trading habits secret, Jean Levine, an analyst at Thomson Financial, said shorting corporate bonds is "a common practice in the markets."

Some believe this selling has been picking up momentum recently, which has hurt stock prices in two ways. First, as short-sellers have pushed the price of corporate bonds down, yields have gone up, making these investments more attractive relative to equities.

Second, companies rely on tapping the credit market to raise money, either for capital spending or to pay off debt. But with the spread between corporate bonds and U.S. Treasuries widening, companies must now pay much more to issue credit.

A single A-rated bond traded at 40 basis points over U.S. Treasuries in 1997, but that spread has since widened to between 160 and 170 basis points, according to Chase's Cunningham.

Another source said that triple B-rated bonds traded at 60 or 70 basis points over Treasuries before the Asian financial crisis, but now trade at a spread of 240 basis points. "Those are real costs that firms have to pay if they want to borrow money," he said.

Limited Access

As yields on Treasuries have fallen almost as much as spreads have widened over the last 18 months, however, Cunningham argues that all-in borrowing costs are not prohibitive. Instead, he believes the real problem is access to credit.

"In the second half of the 1990s, access to credit was too easy," he said. "So now we need to go through a period where demand for credit or access to credit is restricted, so we can get our balance sheets into shape."

Tapping the debt markets for capital has become a crucial source of income for many companies in the U.S. Some 55% of the debt currently sitting on corporate balance sheets has come from the capital markets, compared with just 35% back in 1985. Meanwhile, only 13% of the debt on company balance sheets has come from banks, compared with 22% in 1985.

"Capital markets have become the bank for corporate America," Cunningham said.

Powerful Waves

For this reason, some observers argue that shorting corporate bonds is bad for the economy. Pimco bond manager Bill Gross said on his Web site Wednesday that it's more destructive than shorting stocks because it can lead to a wave of institutional selling.

Many institutions are required by state regulations or internal guidelines to hold bonds of a certain quality. If hedge funds push the price of these bonds down, and as rating agencies issue downgrades, some of these institutions are forced to liquidate, Gross reasoned.

"

Standard & Poor's, Moody's and Fitch are extra-sensitive to the perception that they moved too slowly with

Enron

and other corporate rating disasters," he wrote. "By pushing a company's bonds down in price and up in yield they sometimes, sometimes, can initiate an agency downgrade into the world of junk bonds and out of the world of investment grade."

Of course, Gross has a vested interest. His fund recently took positions in high-yield corporate bonds and telecom debt, most notably of

AT&T

(T) - Get Report

and

Sprint

(FON)

.