Lawmakers seeking to avoid a default on U.S. debt are so far getting little pressure from financial markets, which in the past have provided the impetus to break fiscal deadlocks.
The Standard & Poor’s 500 Index remained near last month’s record and Treasuries declined today amid reports that lawmakers continued to negotiate a deal to raise the debt ceiling two days before the government’s borrowing authority lapses. Senate leaders are poised to reach an agreement as early as today, while House Republicans may seek to block or change any pact.
Congressional leaders probably would have responded more quickly and held more meetings in recent days had they been forced to make a deal by financial markets “collapsing,” according to Representative John Delaney, a Maryland Democrat and member of the House Financial Services Committee.
“Government seems to need forcing functions,” Delaney said today in an interview in Bloomberg’s Washington bureau. “Unfortunately we’ll wait to the last minute because the market is giving us the flexibility to wait.”
The S&P 500, the benchmark for U.S. stocks, fell 0.7 percent to close at 1,698.06 after rallying 3.3 percent in the previous four sessions. The Dow Jones Industrial Average declined 0.9 percent, or 133 points, to 15,168.01. The U.S. 10-year yield rose 0.04 percentage point to 2.73 percent.
Should the Dow tumble 400 points or more, “that’s going to get people’s attention, but we don’t need to be there,” said Representative Jim Renacci, an Ohio Republican who is on the Ways and Means Committee.
“Markets realize that there’s a deal going on and it’s being brokered, but at any time of course perception can overrule reality and, boom, we can have that fall,” Renacci said today in an interview. “Hopefully that’s not the case.”
The Chicago Board Options Exchange Volatility Index, a gauge of derivatives to protect against stock-market losses, increased 16 percent to 18.66. The VIX, which tracks 30-day contracts, remains below last week’s three-month high.
“Congress hasn’t felt the market pressure,” said Edward Lashinski, the Chicago-based director of global strategy for futures trading at RBC Capital Markets LLC, a primary dealer that trades government securities directly with the Federal Reserve. “If investors were much more panicked and fearful, we might have seen a deal by now. There’s still a belief in the market that they’re not going to allow a default because everyone agrees it would be catastrophic.”
The federal government is in the 15th day of a partial shutdown, and on Oct. 17 will run out of room to borrow more unless Congress acts to raise the debt ceiling, according to Treasury Secretary Jacob J. Lew.
The 2008 collapse of Lehman Brothers Holdings Inc. provides a lesson in how a plunge in financial markets can concentrate the minds of lawmakers.
With markets still tumbling two weeks after Lehman Brothers filed for bankruptcy, the House of Representatives on Sept. 29, 2008 rejected the George W. Bush administration’s $700 billion plan to rescue the financial system. The S&P 500 tumbled 8.8 percent that day, the most since the 1987 crash, and the Dow Jones Industrial Average lost 778 points for its biggest one-day point drop ever.
Four days later, the House passed the rescue plan, designed to unlock credit markets and safeguard the nation’s banking system, on a 263-171 vote. The tumble in stocks “served as a wake-up call,” Democratic Representative John Yarmuth of Kentucky said at the time.
A plunge like that may not be needed for lawmakers to make progress, though “it would accelerate the process and call attention to the fact that they are the problem,” according to Robert Doll, who helps oversee $117 billion as chief equity strategist at Chicago-based Nuveen Asset Management LLC. While investors may believe Congress would not let the U.S. default, keeping markets calm, a major market loss such as in 2008 “would force them to do something,” Doll said.
“I’m surprised the market has hung in there as well as it has,” Doll said. “It’s sort of a double dare. Markets assume they won’t default, and maybe the politicians assume they don’t have to do anything until the market says we have a problem.”
The $12 trillion of outstanding marketable government debt is 23 times the $517 billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008. The U.S. stock market lost almost half its value in the five months following Lehman’s failure.
In 2011, the S&P 500 tumbled 7.3 percent in the 18 trading day period that ended when President Barack Obama signed a compromise bill to raise the U.S. debt limit by at least $2.1 trillion. He signed the bill on the day the Treasury warned U.S. borrowing authority would expire.
Now, market reactions help offer lawmakers political cover to back down from their hard-line stances, said Tony Fratto, a U.S. Treasury assistant secretary in the George W. Bush administration and founder of Hamilton Place Strategies, a Washington-based consulting firm for financial companies.
“That just makes it easier from a political standpoint to make that case back home,” he said. “Absent a big external shock, you’re just faced with the reality of going home with your tail between your legs and admitting that you lost.”
Failure by Congress to reach a deal before Oct. 17 may be enough to trigger the market reaction needed to jolt lawmakers into an agreement, he said. “It’s got to be big and significant and noticeable” he said.
Senator John McCain, an Arizona Republican, said lawmakers will realize the impact of a failure to raise the debt limit when markets plunge.
“Watch the markets,” McCain said in an interview last week. “That’s the arbiter of all of this. I think the markets are going to go down as soon as we default. That’s what people on Wall Street tell me.”
Daily S&P 500 swings have averaged 0.78 percent so far this month, down from 0.9 percent for Octobers over the last eight decades and less than a quarter the moves in 1929, 1987 and 2008, data compiled by Bloomberg show.
“Markets have gotten a bit inured to what’s going on” in Congress, said Brian Jacobsen, who helps oversee $226 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “When push comes to shove, they’ll make a deal in the last minute.”
Markets may be calmed by investors who believe that the government can meet its obligations beyond the Oct. 17 deadline, and that lawmakers are certain to forge some sort of extension before triggering a default, according to Joseph Carson, director of global economic research at New York-based AllianceBernstein LP, which has $445 billion in assets.
“The markets are already priced to some type of resolution whether in six weeks or six months,” Carson said. “If the market was going to enforce some discipline on politics, then bond yields wouldn’t be under 3 percent.”
The U.S. won’t default even if Congress and Obama fail to reach a deal to increase the debt limit, Republican Senator Tom Coburn of Oklahoma said in an interview last week.
The absence of a debt-limit increase “doesn’t mean there’s a default,” Coburn said. “That means the debt limit hasn’t gone up.”
“There is not going to be default. Period.”
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