The confidence fairy strikes back
by David Atkins ("thereisnospoon")
Dave Dayen has been tremendous in his coverage of the default crisis generally, and his latest take on the S&P shakedown of the U.S. economy is no exception:
This concern about the markets has happened very suddenly. All of a sudden there’s a belief that a clean increase or a small debt deal with a minor amount of spending cuts would not be enough to avoid a downgrade. Standard and Poor’s basically forced this by saying that they would downgrade if there wasn’t a $4 trillion deficit deal in the next 90 days. The claim is that this has been caused by political leaders attaching the debt limit to a deal on reducing the deficit, and the inability to reach an agreement, the political stalemate, has led the markets to lose confidence.
But this is absolutely crazy. The market was up 2% last week. 10-year Treasuries are at 2.96%. There’s no difference between this week and last week in terms of the country’s deficit problem. This is about perception, and it doesn’t seem to even be about the perception of the actual market. It’s about the perception of someone at Standard and Poor’s. The rating agencies, which played a major role in the financial meltdown, has just up and put a gun to the head of the country and demanded austerity in the middle of a jobs crisis. Are you kidding me?
Washington certainly deserves blame for attaching a huge lift of deficit reduction to the debt limit, which is so routine but which has such adverse consequences. But this is completely irresponsible on the part of not just DC but the rating agencies. The word “collusion” comes to mind, with the elites of the world demanding that their tax cuts be paid for with someone else’s money.
Dave is right to suspect some form of collusion, given the close relationship between Wall St. and Washington's most powerful players in both parties. Anyone familiar with the history of the TARP fiasco and the effort to whitewash the MERS scandal would be wise to consider the possibility of foul play here.
But on the other hand, this is also an inevitable consequence of Washington gamesmanship when it comes to the markets. Contrary to deeply held conservative beliefs, markets are fundamentally irrational. Jokes about confidence fairies notwithstanding, markets are as susceptible to both panic and irrational exuberance as any herd of wild animals. When push comes to shove, the masters of the financial universe are no smarter or more rational than anyone else: they just happen to siphon a lot more money off the rest of the economy through esoteric means than do the rest of us.
And just like a herd of not-too-bright animals, all it takes to start a mini-panic is for just one of the players to get nervous. In the case of today's financial markets, the first people to get nervous will be either the ratings agencies or the bondholders. The ratings agencies have taken a lot of fire for overinflated ratings in the past, and are now likely to overcorrect by trying to get ahead of the market, lest they be seen again as the functionally useless entities they really are. In that sense, it's no surprise that S&P would be the first to get wet feet. The bondholders, on the other hand, have remained fairly confident that some sort of deal will happen to avert disaster--though that confidence could certainly evaporate by Monday, particularly if the ratings agencies get spooked and the Asian markets tank. Remember that the supposedly brilliant bondholders were dumb enough to believe that the initial TARP vote would sail through Congress, then panicked like schoolchildren before a crowd of vicious raptors immediately thereafter. Much as these people like to elevate themselves as the smartest guys in the room to justify their obscene wealth, they're not terribly bright or savvy.
Have any economic fundamentals changed between now and last week? No they haven't. It's true that the economy is already being hurt to some degree by the ongoing impasse. But fundamentals don't really drive the market. If they did, the market wouldn't be soaring as the real economy continues to tank. The market is driven by perception, panic, exuberance and greed, particularly among the wealthy classes and their friends.
As I've argued before, market jitters are just the next act in the kabuki play, the necessary condition for nervous nellies in each caucus to give in and go along with whatever villager-approved Grand Bargain is on the table. It's not a question of if it happens, but when.