What does Wall Street know that Washington lawmakers fail to see?

Wall Street is signaling confidence that lawmakers will strike a deal to avoid the “fiscal cliff,” baffling Washington insiders, who see less reason for optimism.

Stocks began to make a comeback Friday after President Obama and congressional leaders suggested that talks on the cliff’s spending cuts and tax increases were off to an auspicious start.

ADVERTISEMENT
The Dow Jones Industrial Average continued the rally on Monday, rising 207 points and ending the day up more than 300 points since Friday’s meeting at the White House. The S&P 500 edged up 27 points.

Bank of America CEO Brian Moynihan and Nasdaq Chief Executive Robert Greifeld were among the financial players expressing confidence about the negotiations in Washington. 

“It’s been encouraging over the last few days,” Moynihan told Bloomberg Television on Monday.

Greifeld, meanwhile, told a Brookings Institution audience that he thought leaders would strike a deal, or at least find the framework for one, before the lame-duck session of Congress is through.

“I do believe that cool heads will prevail,” Greifeld said.

Dan Alpert, a managing partner at Westwood Capital, suggested that markets were just now catching up with the reality that the president and Democrats have the upper hand in fiscal-cliff negotiations, making a deal more likely.

“The market woke up on Friday to the reality that Obama had won, and that the country had voiced a strong opinion on their desire not to see the Republican agenda go forward,” Alpert told The Hill. “One thing that financial markets and the industry and traders are acutely aware of is relative advantage.”

That assessment left Washington’s legislative veterans scratching their heads.

“This proves once again that equity markets really and truly do not understand Washington, D.C.,” said former Senate Republican budget staffer Steve Bell, a former managing director of Salomon Brothers who is now at the Bipartisan Policy Center.

“They are singing ‘Kumbaya’ in public. That is what they always do,” said Bell.

He said the next step in the Washington dance is for leaders to go back to their caucuses with details.

“The more detail, the more people drop off,” Bell said. “I don’t know that there is a deal to get a majority of the House Republican caucus.”

Obama and Democrats are demanding that the wealthy pay a higher tax rate as the price of avoiding the “cliff.” Republicans, meanwhile, are dead set against higher rates, and are insisting on significant entitlement reforms to Medicare, Medicaid and Social Security that liberals strongly oppose.

Privately, Republicans concede that the scheduled expiration of the Bush-era tax rates gives Obama a tactical advantage, but experts say the president also has a strong incentive to cut a deal.

If the economy goes over the fiscal cliff and tumbles into recession, Obama’s second term-agenda could collapse right along with it.

“We are in Act 1, where it really looks like there is a chance Romeo and Juliet can get together,” Bell said, noting that William Shakespeare’s play ends in a double suicide.

Party leaders on Friday promised to have their staff work toward a solution through the Thanksgiving break, though Obama has been out of Washington since Saturday on a trip to Asia. Few in Washington expect to see results.

“You had no choice but have the first meeting sound positive. What that doesn’t mean is that a deal is in the works and it will happen by the end of the year,” said Ron Bonjean, former aide to House Speaker Dennis Hastert (R-Ill.).

Jim Manley, a former spokesman for Senate Majority Leader Harry Reid (D-Nev.), said it was encouraging that the four congressional leaders briefed reporters together on Friday.

But Manley, now at QGA Public Affairs, said it was common for top lawmakers to huddle after meetings to decide whether they should offer a united front. He said leaders are well-aware of how their actions and comments can move the markets.

“They obviously decided, as part of their discussions, to go out and send a signal to the markets. But that’s still a long way from getting a deal that’s going to qualify as satisfying the markets,” Manley said.

Manley added that, to get to that deal, he believed Speaker John Boehner (R-Ohio) and Senate Minority Leader Mitch McConnell (R-Ky.) would have to stand up to the right flank of their party.

But the former Democratic aide also said he saw some roadblocks to that happening, including McConnell potentially trying to guard against a 2014 primary challenge.

Inside the Capitol, caution about the talks abounds.

“I’m looking at the market and I’m thinking, ‘Wow’ … [leaders] made a nice statement … but the devil is in the details,” a Senate Democratic aide said Monday. “I’m usually an optimist, but all Boehner and McConnell said was what they have been saying all along: Extend all the Bush rates; do tax reform later.”

The conventional wisdom is that staff will present leaders with an option for a two-part deal after Thanksgiving, with a down payment voiding the $109 billion in sequestered spending cuts and a framework requiring tax and entitlement reform in 2013 with a punishment trigger.

“There is a lot of things that can go wrong,” said Bob Bixby of the Concord Coalition.

The biggest of those question marks is what to do with the marginal income tax rates. Obama insisted on the campaign trail that those rates need to rise for the highest earners, but a possible compromise could still keep rates below the 39.6 percent top rate enacted under Bill Clinton. 

Even though Republicans oppose higher rates, they have wiggle room to claim revenue results from economic growth. And while the White House campaigned against turning Medicare into a voucher, it has not ruled out less dramatic changes to the program.

Bixby said the differences between the parties could be overcome in a bridge agreement with fiscal targets that could be as vague as requiring revenue to reach a certain percentage of gross domestic product, or setting a dollar-figure target for savings from a “healthcare” category.

“I have always thought the fiscal cliff would be avoided. In that respect I don’t think the markets are off base,” said Steve Ellis of Taxpayers for Common Sense.

But Ellis said the rhetoric so far is part of a “standard script.”

The Friday meeting was “boy meets girl,” while the appearance of concrete offers and the caucus reactions will be the “boy loses girl” part. Whether and how negotiators get to “boy gets girl in the end” remains to be seen, Ellis said.