- Corporate America's burgeoning scandals are proving harder
for the financial markets to shake off than September's terrorist attacks.
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- Seem like a stretch? Not by much.
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- Within weeks of Sept. 11, consumers, investors and most
business sectors were on their way to shrugging off most of the fallout.
Moreover, the U.S. dollar and financial markets were considered havens
for skittish global investors.
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- No longer. The string of alleged corporate malfeasance
extended Wednesday as the Securities and Exchange Commission charged WorldCom
with fraud. In reaction to what could be one of the largest accounting
scandals ever, the Nasdaq composite and the Standard & Poor's 500 indexes
sold off sharply in early trading.
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- Though most losses were erased by the market's close,
Wall Street's leading barometers are dangerously close to five-year lows.
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- Corporate scandals aren't the sole reason financial markets
continue to falter. The dollar continues to weaken, and consumer confidence
is at its lowest since February. Lingering threats of terrorism, lackluster
corporate earnings and the soft economy are crimping stock prices.
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- Nevertheless, many market sages blame Wall Street's latest
declines largely on the corporate misconduct that is undermining investor
confidence at a time when some say economic conditions should be creating
a base for a long overdue stock rally.
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- During the past several weeks, few things have spooked
investors more than fresh allegations of corporate wrongdoing. They cut
a swath through telecommunications, energy, financial and industrial companies.
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- WorldCom. Enron. Tyco. Rite Aid. Adelphia Communications.
Dynegy. ImClone Systems. Suspect credibility of supposedly independent
Wall Street stock analysts and outside accounting firms such as Arthur
Andersen. Wealthy, high-profile entrepreneurs such as Martha Stewart under
regulatory scrutiny for alleged illegal trading on inside information.
CEOs were paid millions and awarded huge stock-option grants despite lackluster
performance.
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- The litany of corporate and executive malfeasance appears
to grow broader and deeper each day. ''It is pervasive,'' former SEC Chairman
Arthur Levitt says. ''This is a result of systemic failures and an erosion
of corporate ethics. Undoubtedly, we will find more companies with problems.''
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- Not that this wave of corporate troubles is unique. The
market bubble of the 1920s was a precursor to scandals well into the following
decade. The 1980s were marked by inside trading and the savings-and-loan
crisis. Still, no collection of corporate problems has had such an impact
in recent memory -- killing jobs, eviscerating investment portfolios and
disrupting scores of honest companies teamed with troubled firms. And the
woes have been a setback for American corporate credibility, management
style and accounting methods that regulators and businesses had long touted
as a model for foreign competitors.
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- ''We should be eating a fair amount of humble pie,''
says Edward Snyder, dean of the University of Chicago Graduate School of
Business. ''This market is going to be adjusting in very significant ways.
When we do, the real test will be, where do (global investors) put their
money?''
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- Shaking investor confidence
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- WorldCom's tailspin has wiped out nearly $160 billion
in investor holdings. Based on market capitalization, Enron was once the
seventh-largest U.S. company. Each wave of corporate scandal has left Wall
Street far more volatile -- and reactive -- to bad news, with 200- and
300-point intraday market swings increasingly common.
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- Investors are ''collectively dumbstruck,'' says John
Markese, president of the American Association of Individual Investors.
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- At Charles Schwab, the nation's largest discount brokerage,
annual trades have plunged to an average of just 3.6 per account compared
with more than eight in 2001.
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- Yet paralyzed investors can send the market tumbling
just as surely as panic-stricken sellers. People sell stocks and mutual
funds all the time, but buying usually overwhelms the selling. For example,
in January 2000, investors yanked $92 billion from stock mutual funds.
But they invested $132 billion, for a net inflow of $40 billion.
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- In April -- the latest monthly data available -- investors
pulled $75 billion from stock funds. They invested $88 billion. TrimTabs
Investment Research, which watches fund flows, says June selling has overwhelmed
buying, estimating that $20 billion has already been pulled from stock
funds this month.
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- Individuals have more reason to be unnerved: Many mutual
fund managers have been sandbagged, too, by holding sizable chunks of WorldCom
and other former highfliers such as Lucent Technologies, Enron and Tyco,
according to Morningstar, the Chicago-based stock research company.
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- How much more can investors tolerate? Not much, Markese
says.
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- Beyond Wall Street
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- Corporate scandals aren't expected to derail the economic
recovery. But they could soften the economy's moderate upswing, analysts
say.
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- ''There could be a negative shock to the economy coming
from this,'' says Brookings Institution senior fellow William Dickens.
''Probably not all that big of a magnitude, but not trivial at this point
either when the economy is struggling to recover.''
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- The primary impact will be through the stock, bond and
currency markets. What could happen:
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- * A drop in consumer confidence. ''The stock market,
if it continues to swoon, holds the potential to knock consumer confidence
and spending back,'' says Stuart Hoffman, chief economist at PNC Financial
Services Group.
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- When consumers see their portfolios shrink, they feel
less wealthy and less willing to spend, many analysts believe. That's a
big deal because consumer spending accounts for two-thirds of U.S. economic
activity. But economists note that even during the recession, consumer
spending, especially in the housing market, was strong. That's expected
to continue, albeit at a moderate pace.
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- * Rising capital costs. Companies could have a harder
time raising money to invest in equipment and technology. Corporate investment
nose-dived last year. So far, there's scant evidence companies have picked
up spending. If investor confidence wanes, it will be harder for firms
to raise money through stock and bond issues. ''The higher the cost of
capital is, the weaker the capital spending is,'' says Clare Zempel, chief
economist at Baird in Milwaukee.
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- * A lower dollar. Compared with major world currencies,
the dollar is trading at its lowest level since February 2001. Part of
that is because of the country's growing trade deficit and another part
is that the dollar was long viewed as overvalued. But accounting scandals
have also had an impact. Says Lara Rhame, senior economist at Brown Bros.
Harriman in New York: ''It's one more reason for foreign investors to look
for returns within their boundaries.''
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- A slumping dollar can lead to declines in stock prices
as foreign investors dump increasingly less valuable stocks. It also makes
traveling abroad more expensive for Americans and poses an inflationary
risk, because imports -- which the USA relies heavily on -- grow more expensive.
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- * Rising unemployment. The accounting scandals are hitting
big companies that employ thousands and thousands of people. WorldCom's
latest woes will force it to lay off 17,000 employees, or 21% of its workforce.
As troubled firms lay off employees, the job market softens further, leading
to decreased consumer confidence and spending.
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- Fixing problems
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- Just how to fix things -- or whether things can be fixed
-- is under considerable debate.
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- ''Every time we think all the dirty laundry is out and
everybody has a picture of what reforms and strategies are needed to rebuild
trust -- boom, there's another scandal,'' says Carol Bowie of the non-profit
Investor Responsibility Research Center. ''I hope we've seen all of the
different problems by now. But I'm not sure what to predict at this point.''
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- Executive pay -- which has soared over the past decade
-- is still largely predicated on short-term stock performance. That can
give executives a motive to goose earnings.
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- ''It has become out of control -- the numbers, the amount,
the value of stock-option awards and restricted shares and outright grants,''
says Judith Fischer, managing director of pay tracker Executive Compensation
Advisory Services. ''It's become so enormous and egregious that there is
a chance . . . executive decisions will be made (purely) to enhance stock
price.''
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- With the fallout at Enron and elsewhere, corporate directors
are under more pressure to act less like management cronies and more like
the shareholder watchdogs they're supposed to be. Critics say corporate
boards also need overhauling -- too many independent directors have cushy
consulting or business deals with companies on whose boards they sit.
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- Rep. Billy Tauzin, R-La., who chairs the House Energy
and Commerce Committee, says WorldCom highlights the need to pass accounting
reform and investor protection legislation to prevent corporate abuse and
restore investor confidence. Yet, so far, corporate lobbyists have thwarted
congressional efforts to tighten controls and curb fraud.
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- Just how long current woes could last -- and how broad
they become -- is also open to debate.
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- ''We've been here before, we'll be here again,'' Levitt
notes. ''This is just a rerun of what we've had many times before -- the
hangover of a huge market binge.''
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- Copyright © 2002 USA TODAY,
a division of Gannett Co. Inc.
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