Bull, Bear or Dead Cat?

Over at Volokh, Stuart Benjamin implies it was purely partisan to attribute the market fall to Obama. It is indeed more complicated than anyone can reliably figure, but if that’s where our analysis must stop, the Democrats shouldn’t have tried to tie Bush (and by extension, McCain) to turmoil in the markts.

Policies have costs and benefits. Markets are all about pricing in expectations. As the first commenter points out, the real question is when to start to hold Obama (and, just as importantly, the enlarged Democratic congressional majority) accountable. Inauguration day gave us little if any new information. In fact, the interesting correlation is between the real inflection point in the indices in mid-September of 2008 and Obama’s emerging electoral inevitability. In that case, though, the causality is mixed, but probably skewed toward the markets-causing-Obama, not the other way around. (On one hand, the Palin choice doesn’t work out as planned, helping Obama and potentially moving the markets. On the other, the credit crisis makes landfall — probably independent of political events — and the markets influence politics.) But the declines since election day are at least plausibly due to expectations about Obama. (Remember when markets rallied on Geithner’s naming?)

The run-up over the last couple weeks has been largely due to (1) the Fed’s quantitative easing (which even Paul Krugman is acknowledging blurs into essentially a huge deficit spending proposal) to keep the cost of capital to financial institutions unusually low and (2) the private-public partnership to buy up toxic assets, whereby the USA takes most of the downside on the assets while hedge funds get most of the upside for a very small share of the risk. Obama is telling the markets that the US will bear the cost of all the bad decisions by “too big to fail” financial institutions. Both of these developments amount to a demonstration that the Obama administration will basically through several trillion dollars of taxpayer money (most of it in the future) at the toxic assets in order to relieve the financial system of those liabilities without either (i) removing management of the institutions that create the mess (ii) wiping out the equity of the same or (iii) forcing a major haircut on the debtholders. Of course those Wall Street is cheering; the dominant financial institutions have been spared a (deserved) death sentence. The costs have been shifted to the taxpayer, albeit covertly and in a manner that will only become apparent in the future. It’ll take a while until all the costs to the economy of this gambit will become apparent and be priced into the markets.

The other thing that’s feeding the market a bit is that EFCA is looking like it won’t survive in its full-blown horror.

I hope I’m wrong, but I don’t see the markets regaining Sept 2008 levels (adjusting for inflation) for any extended period until after Obama is gone. He’s struggling to keep them afloat by any means through the next election; sometime after that inflation and increased government cost of borrowing will become his albatross.

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