Traders are bidding up stocks and other so-called risk assets on expectations Washington will manage to put together a deal to reopen the government and raise the debt ceiling, ensuring the U.S. won’t default.
But for Markus Schomer, economist at PineBridge Investments, that is the worst-case scenario.
Schomer, in a telephone interview, argued that another debt deal that kicks the can down the road, setting up yet another fiscal showdown in a few months, is potentially a worse outcome than a default. While missing payments certainly “wouldn’t be good,” he contends it would probably spur the kind of market carnage that would force politicians to come up with a long-term deal. And that, he believes, would be better for the nation’s fiscal outlook, as well as for near-term economic performance.
Schomer reaches back to the darkest days of the financial crisis for some compelling corollaries. Here’s one: A temporary budget deal would be much like the collapse of Bear Stearns in March 2008, he says. While many at the time mistakenly thought the investment bank’s demise marked the bottom of the crisis, it was merely a way station on the path to a meltdown, which culminated in the carnage that followed the fall of Lehman Brothers in September 2008.
A default, on the other hand, would be more comparable to the Lehman drama, he says. While that was an ugly episode, it did create the impetus for the TARP program, which was “the first step out of the crisis.” A deep market selloff is often credited with convincing lawmakers to pass the controversial legislation. Once it was in place, markets were poised for the current bull rally, which got under way a few months later in March 2009, Schomer notes.
The fact that an economist sees the prospect of markets revisiting Lehman as a potentially positive turn of events is yet another sign of just how dysfunctional Washington has become. But Schomer makes some compelling points.
He argues, for instance, that without a long-term deal, the continued, constant threat of renewed fiscal turmoil will continue to limit economic growth. That means sluggish employment growth and an environment where corporations are unlikely to want to boost investment.
In turn, that means the Fed would be unlikely to begin tapering before 2015.
Schomer holds out hope that lawmakers will somehow scramble for a compromise, perhaps revisiting the Simpson-Bowles budget proposals. Meanwhile, stocks may be able to muster another run higher if a temporary budget deal is reached, but gains are unlikely to last, he says.
[by William L. Watts, writing for MARKETWATCH]
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