As the fiscal cliff looms and Democrats and Republicans have dug in their heels, some in Washington think it may take a replay of the drama surrounding the 2008 bank bailout to get a deal done.
The Emergency Economic Stabilization Act of 2008, which established the Troubled Asset Relief Program to inject capital into several major banks, failed when it was first put to a vote in the House of Representatives. After a severe market reaction—the Dow Jones Industrial Average suffered its largest single-day point drop ever—a revised bill was passed by the Senate, and later the House.
Could it be that an economic backlash is the necessary impetus to push some reticent legislators to compromise on an unsavory bill?
“There’s a real chance that they reach a deal and it fails in the House, and then you get something like TARP—a severe market reaction and then they come back and do it,” said American Enterprise Institute scholar Norm Ornstein when he spoke to National Journal earlier this week.
Ornstein wasn’t alone among D.C. political types in suggesting that TARP could be a blueprint to a deal. But it’s a scenario economists and political risk experts have a hard time envisioning, in part because they are so confident a deal will be reached in time to avert the combination of tax increases and automatic spending cuts set to hit the economy next year.
“Right now I think the markets are assuming that there’s going to be a deal at the 11th hour,” said Joseph Lavorgna, the chief U.S. economist at Deutsche Bank.
Similarities between the two economic crises also have a limit. The 2008 TARP bill forced legislators to act on an issue they had little time to consider amid dire but vague warnings of how it might affect the economy. The debate over the fiscal cliff has been lengthy and premeditated.
“They’ve all been thinking about it for a year, the election was fought over it, Boehner knows what his caucus can take, he knows what they can't take, and his caucus knows what the price of crossing him will be,” said Sean West, the U.S. practice head and director for the Eurasia Group, a global political-risk research and consulting firm.
That sentiment was echoed by Rep. Jim Gerlach of Pennsylvania, a Republican who originally voted against the TARP legislation in 2008 but then changed his vote after Federal Reserve Chairman Ben Bernanke held a conference call with the Pennsylvania delegation “painting … a very bleak economic picture if we did not pass the TARP legislation.” Gerlach also said it was important that the revised bill added a provision that required banks that used toxic assets repay the money.
This time, he says, he’s been steeped in the issues for much longer.
“During the campaign, we talked a lot about not supporting increased taxes because we felt and feel that that’s not the way to strengthen the economy and that we’ve got to get a handle on our long-term spending,” he said. “That was very much part of the campaign, very much part of my interaction with voters this year.”
There’s also the possibility that if the prospect of compromise starts to go too far south, the markets will begin to react negatively and give lawmakers the push they need to reach a deal.
“There is the risk that business and consumer confidence are affected even before it comes to a vote as people increasingly get worried,” said Jim O’Sullivan, an economist at High Frequency Economics. But he predicted it would take a pretty serious breakdown—such as everyone walking out of talks—to prompt a stark market reaction.
West said his firm only puts the risk of going over the fiscal cliff at about 20 percent, in part because the market has feedback mechanisms that will react before a failed vote could even occur.
“It’s not like they’re going to need a failed TARP vote to knock 10 percent off the market, that’s just going to happen if it’s clear there’s not going to be a deal, and Congress is going to have to decide whether it cares or not,” he said. “If no deal is likely, CEOs facing the sequester start to lobby pretty hard and reminding people that they just sponsored their reelection campaigns.” Constituents won’t be very happy either, he said.
Business groups have vocally advocated for a resolution, and a meaningful one. “The business community believes driving off the cliff is not only bad economics, it is bad politics, and should be avoided,” said Blair Latoff, the senior director of communications for the U.S. Chamber of Commerce. “The larger issue for business and our economy is to get a Big Deal that begins to stabilize debt, reduce spending, restrain entitlement spending growth, and restructures the tax system.”
Economists are also hedging their guesses as to whether the market reaction would be big enough to really push lawmakers to go back and reach a deal if their attempts failed and they went over the cliff. Businesses have had enough time to prepare for a worst-case scenario by slowing hiring and production to lessen an impact.
“We’ve already seen a decline in businesses sentiment, at the CEO level, small-business sentiment, and now household sentiment. The confidence effects appear to be now quite large if we go off the cliff, so it’s hard for me to think that you don’t get a negative reaction in risk markets,” Lavorgna said.
“But who knows,” he added. “Maybe you don’t?”
Markets have been fairly calm in recent days, with a slight dip in confidence levels but no major shocks to the system even as cliff negotiations seem stalled. Drawing on the debt-limit debates of August 2011, Bernanke said that wasn’t necessarily unusual.
“Both confidence and markets remained pretty sanguine up until pretty close to the point where, like, there was actually a chance the debt limit would not be … raised. And then, of course, there was a pretty sharp shock, particularly to confidence, about the time of the, of the final debate, so it’s not unusual to see markets being complacent,” he said at a Wednesday press conference.
But he urged policymakers to act based on what would be good for the country, not the markets.
“I don’t think any policymaker, including the Fed, should be responding to markets. What we should be doing is making policy, you know, based on fundamentals including what’s best for the economy, and I hope that fiscal policymakers will follow that injunction as well,” he said.