What a Week: Death by a Thousand Paper Cuts

As Congress investigated Enron, Tyco embodied an accounting massacre that didn't stop.
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The market was unable to stop hemorrhaging from a deep cut suffered Monday. The rest of the week basically amounted to a desperate attempt to stop the bleeding.

Stocks rallied sharply into the close on Friday, but the

Dow Jones Industrial Average

still fell 1.6% for the week, while the

S&P 500

shed 2.3% and the

Nasdaq Composite

lost 4.8%.

With the congressional hearings on

Enron

(ENRNQ)

as a backdrop, the issue weighing on stocks this week wasn't hard to find: widespread concerns about corporate accounting.

"A bull market and a strong economy hide ineptitude and aggressiveness," wrote Kent Engelke, capital markets strategist at Anderson & Strudwick in Richmond, Va. "We return to the dead-fish-in-a-barrel analogy: All the fish appear to be alive as the barrel is stirred, but the moment that stirring is stopped, the dead ones rise to the surface. The economy is slow, and yesterday's abuses are now coming home to roost."

The week's most obvious fish was

Tyco

(TYC)

, whose shares tumbled 16.2% following a seemingly never-ending barrage of news.

The week began with revelations that Tyco spent billions on hundreds of acquisitions which it never disclosed.

RealMoney.com's

Herb Greenberg reviewed those developments

last Friday and Tyco shares dropped 19% Monday after

The Wall Street Journal

picked up the story.

Concerns about Tyco's accounting, and its announced plans to draw down its $5.9 billion credit line, were widely credited with sparking Monday's big decline. Monday's drop appeared climactic, but proved to be a prelude for more bad news for both Tyco shareholders and the market overall.

On Tuesday, Tyco announced it was drawing down another $8.5 billion from its bank lines; but rather than reassuring investors of the company's financial strength, it gave them the impression of a firm in distress, and Tyco shares fell another 22.3%.

The broader market losses Tuesday were modest, relative to Tyco's. But a profit warning by

Ciena

(CIEN) - Get Report

and a bigger-than-expected loss by

Sprint PCS

(PCS)

, plus a weaker-than-expected report on the Institute for Supply Management's nonmanufacturing index, held back the market's rebound attempt.

Surely Wednesday would bring some relief

both for Tyco and the broader market, thought the bulls. Tyco shares did rebound, despite the company's warning that its earnings would not meet expectations. But Tyco's reprieve and an early release of better-than-expected results at

Cisco

(CSCO) - Get Report

failed to ameliorate investor concerns about accounting.

Firms such as

WorldCom

(WCOM)

,

VeriSign

(VRSN) - Get Report

and

Qualcomm

(QCOM) - Get Report

were alternately burned this week in what many are calling a "witch hunt" for accounting impropriety.

Bond Market Says What?

Meanwhile,

Computer Associates

(CA) - Get Report

tumbled 13% midweek after Moody's Investors put its corporate debt under review for possible downgrade.

In the wake of their failure to foresee Enron's fall, debt rating agencies appear to be taking a more proactive stance in downgrading corporate bonds. That, in turn, weighed on the shares of many firms as lower bond ratings mean higher borrowing costs for corporate America. Tyco, for example, tapped its bank credit lines after a downgrade of its short-term ratings effectively shut it out of the commercial paper market, a crucial financing vehicle for corporations.

"Although Tyco was fortunate to have the ability to

tap the bank credit, this is not a sign of financial health," commented Carol Levenson of Gimme Credit, an independent credit research firm. "The company lost a flexible, usually forgiving, unsecured and cheap source of funding in exchange for a source with stringent financial covenants and a fixed maturity."

Separately, Marty Fridson, chief high-yield strategist at Merrill Lynch, noted that spreads between triple-B and single-A rated corporate debt expanded from 182 basis points on Feb. 1 to 203 basis points on Feb. 7. That nearly equals the entire range (24 basis points) of those spreads from the beginning of the year through Aug. 31.

Such a huge move in the usually staid corporate bond market is evidence of the gyrations across financial markets, not just equities.

For the bears, this was the week in which all their warnings started coming home to roost. The dollar fell in concert with equities, while Treasury bonds proved unable to benefit from the weakness in stocks. Bonds were hampered by the government's auction of $16 billion of five-year notes and $13 billion of 10-year notes, as well a

challenge to

Fed

Chairman Alan Greenspan to tighten by Pimco's Bill Gross, who manages the $48 billion

(PTTRX) - Get Report

Total Return fund.

Anthony Crescenzi, chief bond market strategist at Miller Tabak, argued the weakness in bonds prior to Friday was "evidence of the dearth of anxiety that exists in the bond market over issues related to corporate governance."

Because bonds are more institutionally driven than stocks, he argued "the signals coming from the bond market are significant and suggest that the anxieties in the

financial markets are likely to dissipate."

Those anxieties certainly dissipated Friday afternoon. But institutions driving the bond market better hope they don't resume, because some might find themselves in dire straits if the week's overriding trends re-emerge anytime soon.

Noting that

gold and related shares were one of the few bright spots this week (and again on Friday), the hardcore skeptics contend that bonds and the dollar are becoming victims of the same crisis of confidence in U.S. institutions that is weighing on stocks.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.