Waiting for the Market’s Call to Reason

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

A few days ago on MSNBC, I made the point that when it comes to the current government dysfunction, I don’t expect the Tea Party Republicans to help (about 13 minutes in).  I expect the party moderates to override them.

I’m still waiting.

What will it take to wake up the moderates such that they insist that House leadership gets us out of this meaningless yet damaging cul-de-sac by letting majority rule on clean bills to patch the budget and raise the debt ceiling?

Historically, one option is a big drop in the stock market.  I vividly recall how a huge drop of almost 800 points in the Dow Jones industrial average in late September 2008 changed the minds of House Republicans on the TARP legislation (a Bush proposal, by the way).  The current shutdown, however, isn’t yet generating anything like that large a reaction.  Instead, we’re seeing a dribble downward, with the market off about 400 points, or about 3 percent, over the seven trading sessions through Monday.

The chart shows the Dow over the last seven trading days and the same number of sessions leading up to Sept. 29, 2008, when the TARP proposal went down in the House, only to be passed a few days later.  The point differences in the drop between then and now are pretty obvious (and since the base was about 10,000 then and about 15,000 now, the differences in percent changes would be even more dramatic).

There’s an economic rationale for the patterns in the figure: the shutdown is not economically analogous to the systemic freeze of global credit that precipitated the TARP (we can have a separate argument about whether TARP was the best tool for the moment, but that’s not my point here).

Failing to raise the debt ceiling, however, is more than analogous to that systemic crash, and while markets appear to have priced in a last-minute agreement to avoid default â€" certainly that’s the lesson of recent history â€" one can see nervousness, both in equity markets and in the rising yields of shorter-term Treasuries.

I suspect that if we continue to hear from people like Representative Ted Yoho (default “would bring stability to the world markets”), a Florida Republican, as opposed to more responsible party members with the courage to wrest control back from the extremists, market expectations and pricing will change for the worse.

Perhaps that’s what it would take to wake the moderates, but one just can’t be sure. The unwillingness to put country ahead of ideology and self-preservation (as in keeping your job) is at a level unfamiliar, if not downright scary, to me.