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Would Supercommittee Failure Roil Markets?

Filed by KOSU News in US News.
November 18, 2011

With next Wednesday’s deadline looming, the congressional supercommittee still seems far from an agreement, causing concern that failure could send financial markets into a spiral.

The bipartisan panel, charged with finding budget cuts or new revenues to reduce the deficit by at least $1.2 trillion over the next 10 years, is a child of the summer’s debt-ceiling debate. It was an escape hatch for Congress and the president when they couldn’t reach agreement on big deficit-reduction measures. That game of chicken helped to send the stock market sliding.

The debt ceiling was eventually raised at the last minute, with a compromise that created the supercommittee. But the political turmoil on display during the debate caused Standard & Poors to downgrade the U.S. credit rating. That move, along with turmoil in Europe, sent stock markets plunging.

Could that happen again? Hugh Lamle, president of M.D. Sass Investors Service, says he thinks even if the committee doesn’t make its $1.2 trillion target, investors will be heartened if it can detail credible progress by next Wednesday.

“[However,] if the deadline is met, but without a really credible solution, I think the markets will react negatively,” Lamle says.

It could look a lot like the stock market losses surrounding the debt ceiling. During the two weeks surrounding that debate, the Dow Jones industrial average dropped close to 2,000 points. Some of those losses were associated with the European debt crisis.

One effect of Europe’s crisis was that despite the U.S. credit downgrade, investors continued buying U.S. Treasury bonds, so U.S. interest rates did not rise. Lamle thinks that could be different this time if investors are badly disappointed. He says if U.S. interest rates were forced up, it would signal serious negative effects for the U.S. economy and the Federal Reserve’s control over interest rates.

“So serious that I doubt that thoughtful members of Congress will permit that to happen,” he says.

Lamle says the lack of a real plan from the supercommittee would further damage of the credibility of the U.S. government.

“Losing credibility is like breaking a glass. You can’t put it back together again very easily,” he says, “and the markets depend upon an assurance that when Treasury bonds and bill come due, they will be able to be paid.”

Anthony Crescenzi, a vice president at the big bond fund, PIMCO, says markets already have very low expectations for the supercommittee — and Congress as a whole.

“Just the idea that there is a supercommittee is evidence that there’s dysfunction because the normal process has broken down,” he says.

That doesn’t mean that investors wouldn’t be disappointed by a total lack of progress. Of course, there’s also the possibility that one of the other rating agencies might decide to downgrade U.S. debt, which could unnerve investors.

One other thing on investors’ minds is the looming expiration of the payroll tax holiday and extended unemployment benefits on Jan. 1. That could take $170 billion out in the pockets of Americans next year and cost an estimated 1 million jobs. President Obama wants both renewed, but Republicans have hesitated.

“This is separate from the supercommittee,” Crescenzi says, “but it’s connected in the sense that if there’s no agreement by the supercommittee, it’s suggestive of the inability of the Congress to work together and an inability, perhaps, to extend this payroll tax holiday and extended unemployment benefits.”

The threat of slower growth in the U.S. could push stocks down.

There has been some talk of a deal that might include significant budget cuts, plus extension of the payroll tax holiday and unemployment benefits. Even if it totaled less than $1.2 trillion in deficit savings, it might soothe investors. [Copyright 2011 National Public Radio]

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