Blinder Says Wall Street May Be Underestimating Impact of Budget Impasse

The risk that lawmakers will fail to reach an agreement on the U.S. debt ceiling may be underestimated by financial-market participants, said Alan Blinder, a former Federal Reserve vice chairman.

“I find too many market people, Wall Street people, unconcerned, which tells me that if this actually happens, it’s going to be like a cold slap in the face,” Blinder said today in a Bloomberg Radio interview. “I don’t know what probability to put on this. It’s not huge. It’s certainly way under 50 percent. But it’s not zero.”

Democrats and Republicans have been negotiating to find a way to cut the long-term deficit and raise the nation’s debt ceiling before the projected end of the government’s borrowing ability on Aug. 2. Two major ratings companies -- Moody’s Investors Service and Standard & Poor’s -- said that failure to reach agreement could put the U.S. government’s top credit rating in jeopardy.

“One of the worst ideas I’ve heard -- but this could actually happen -- is they just raise the debt ceiling enough to let this go another month and then we play it out again, and again, and again,” Blinder said on “On the Economy” with Michael McKee and Sara Eisen. “I don’t view that as a solution. I view that as a horror show.”

In addition to debt concerns, a lagging housing market is also weighing on the U.S. economy. Property values in 20 U.S. cities dropped 4 percent in the year ended in April, according to the S&P/Case-Shiller index released today.

Blinder, 65, an economics professor at Princeton University in New Jersey, said that in the past three years the housing industry hasn’t been producing enough homes to keep up with population growth, a development that could eventually lead to an upturn in the housing market.

‘Housing Boom’

“Eventually we’re going to get a housing boom out of this,” Blinder said. ”It doesn’t look like it’s likely coming soon, but maybe we’ll get a positive surprise on that.”

Blinder said that despite uncertainty surrounding the economic recovery he doesn’t expect Fed Chairman Ben S. Bernanke to begin a third round of so-called quantitative easing. The Fed said on June 22 that the central bank would complete $600 billion in bond-buying -- the second round, dubbed QE2 -- as scheduled this month.

“The severe criticisms that QE2 took both from outside, but also from inside the Fed, more or less assure us that there’s not going to be a QE3 unless things really take a sharp turn for the worse,” Blinder said. “With this kind of muddling-through economy, there won’t be a QE3.”

To contact the reporter on this story: Jillian Berman in Washington at jberman13@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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