By Peter Schroeder and Erik Wasson - 04/12/11 09:51 AM EDT
Wall Street is getting used to high drama in Congress, but the fight over raising the debt limit will test even that seasoned resolve.
If Wall Street saw the fight over legislation to fund the government as playing with matches, it sees the fight over the debt ceiling as playing with plastic explosives, said Steve Bell, a former staff director with the Senate Budget Committee.
“They said that Congress better not think they can play the same shenanigans with the debt ceiling,” Bell said.
Fresh from last week’s deal, lawmakers are turning to the fight over raising the $14.3 trillion debt limit. Republicans say the administration must agree to steep spending cuts to win their support to raise the ceiling by a May 16 deadline set by the Treasury Department.
The administration is demanding a clean bill, but likely realizes it will need to agree to some spending cuts to win a hike in the debt ceiling.
Financial markets already are watching closely.
“What markets typically dislike the most is uncertainty,” said Douglas Holtz-Eakin, the president of the American Action Forum and former director of the Congressional Budget Office. “The more it drags out, the greater that impact will be, and that’s not a good thing.”
Wall Street comes to the debate with the experience of the financial crisis.
“Investors have been conditioned to expect drama,” said Brian Gardner, the senior vice president of Washington research at Keefe, Bruyette & Woods. Thanks to the financial crisis, Wall Street’s understanding of D.C.’s machinations, including political theater, is at “an all-time high.”
Wall Street got a taste of the drama Capitol Hill can serve on Sept. 29, 2008, when the House voted down the Troubled Asset Relief Program (TARP) in the midst of the financial crisis. The Dow Jones Industrial Average responded by dropping over 700 points.
The plunging markets unnerved lawmakers, and the bailout program was passed by Congress days later.
Bell said people on Wall Street are saying that a failed debt-ceiling vote on the House floor would be like the first failed vote on TARP — only worse.
“I think you would have a similar reaction in the bond market and — most people don’t realize this — the bond market is an order of magnitude bigger than the equities market,” he said.
Still, because of the TARP experience, Gardner said Wall Street will not panic as much as the debt-ceiling debate unfolds.
“TARP is not far in the rearview mirror,” he said. “If the debt ceiling doesn’t get raised immediately when it comes up, and investors view that just as a negotiating tactic … then the market reaction will be negligible.”
Over the years, Congress has made a habit of squeezing every drop from the debt-limit debate.
A 2008 study from the Congressional Research Service (CRS) that analyzed previous debt-limit hikes indicates lawmakers have been willing to fill the limit to the brim before increasing it. For example, in 2003, Congress waited to approve an increase until the Treasury had come within $25 million — or 0.0004 percent — of reaching the then-$6.4 trillion limit.
Sen. Tom Coburn (R-Okla.) said this weekend he expects Congress to cut it close on the debt limit, forcing the Treasury to work to avoid a default. Treasury Secretary Timothy Geithner has told Congress that the limit will be reached by May 16, and that the Treasury’s tools can stave off a default on U.S. debt until July 8.
“I think [the vote to increase the debt ceiling is] going to be sometime between June 10 and July 4,” Coburn said on Bloomberg TV’s “Political Capital With Al Hunt.” “That’s how far the secretary has said he can stretch this thing out.”
Congress raised the debt limit seven times from 1996 to 2007 — and six times the Treasury had to take unusual steps to avoid a default before lawmakers approved a boost, according to a February study from the Government Accountability Office.
However, even if Wall Street expects the debt limit to be raised eventually, the stakes are so high they are still prepping for the catastrophic chance Congress fails to act and the government defaults on its debt.
“Banks are already making contingency plans, just in case,” said Gardner.
Jamie Dimon, chairman and chief executive officer of JPMorgan Chase & Co., said in March that he expects every company holding Treasury bonds to begin looking to sell if it appeared the U.S. could default on its debt.
“A lot of people will have to start selling this stuff,” he said at a March 30 event hosted by the U.S. Chamber of Commerce.
“We’d be getting prepared for it way ahead of time. I would be taking really drastic action. It would be really unpleasant.”
Bell said a scare over the debt ceiling could be the “tipping point on the extraordinarily low interest rates” the economy has been enjoying. The scare could therefore slow growth and once again dry up the appetite for lending, he said. The timing of the confrontation during a fragile economic recovery makes it especially perilous.