The New York financial world sits roughly 237 miles from Washington, yet the distance has seemed much longer in the last few weeks as politicians have parried over the fiscal cliff: that noxious mix of tax hikes and spending cuts scheduled to take effect at the beginning of January.
The inaction hasn’t been particularly surprising to Wall Street, but that doesn’t make the lack of progress any less maddening. Analysts and Wall Street economists say they’ve come to expect gridlock from the federal government, which has cycled through similar fiscal fights during the past two years with the Simpson-Bowles commission, the debt ceiling, the failed super committee, and now, the fiscal cliff.
“I’m amazed but also not surprised,” says Joshua Feinman, chief economist and managing director of Deutsche Asset Management, Americas. Cutting a deal “was likely going to go down to the wire and that is what is happening. It’s just to be expected in this Washington environment.”
Part of the financiers’ amazement comes from the fact that politicians cannot seem to overcome well-worn ideologies—an idea foreign to the New York culture of deal-making, where the only true orthodoxy is the bottom line. For the New York financial world, going over the cliff seems crazy since it jeopardizes the economic recovery, potentially dampens rising employment, and could lead to another recession. This isn’t the moment to squabble, from their perspective.
“All they need is political will,” says Sean West, director of Eurasia Group's United States practice.
Two Goldman Sachs analysts have wisely called this tension between the economic and political realities the primary issue for 2013. The trick is to weigh the improvement in the private sector against the “increasing drag from the dysfunction and fiscal retrenchment in public sector,” wrote Jan Hatzius and Alec Phillips in a Dec. 21 Goldman Sachs research note.
Even Ben Bernanke, the chairman of the Federal Reserve, hinted at this disconnect between Washington and New York in his most recent press conference, when he looked to the debt ceiling fight of August 2011 as instructive. Then, he said, the financial markets remained sanguine up until the point when it seemed like the debt limit would not be raised. That’s when the divide between New York and Washington came into sharp relief. “And then, of course, there was a pretty sharp shock, particularly to confidence, about the time of the, you know, of the final debates,” Bernanke said.
The same rhythm of events may repeat if Congress and the White House go over the cliff and cannot reach a resolution by mid-January.
The irony is that the financial community doesn’t actually require too heavy of a lift from lawmakers. Wall Street doesn’t care if D.C. policymakers forego the elusive “grand bargain” this time around, nor do they harp on overhauling of entitlements programs in the short run. They don’t care if Republicans cave on raising tax rates, or Democrats uphold their principles of preserving the social safety net—as long as there is some type of plan so that people know their tax rates for 2013 and so that businesses can plan for profit margins.
“People just want to avoid the disaster scenario and get enough of a deal to avoid the really bad outcome,” Feinman says. “The immediate problem has not been that the deficit is too big. It’s that the economy is not strong enough. Let’s not lose sight of the ball: The economy needs to be stronger.”
The most important aspect of a fiscal-cliff deal, to the New York financial community, is to take any fiscal drag out of the equation by undoing across-the-board spending cuts and by ensuring that huge swaths of people’s taxes don’t go up. Some additional economic stimulus would not hurt either, West says, to continue to boost the economy.
The markets have built time into the holiday season for Washington lawmakers to dither around with the cliff. So far, the markets broadly have tolerated dueling press conferences, behind-the-scenes offers, phone calls between the White House and congressional leadership, and the rollercoaster of deal-making that makes a compromise look promising one day, and hopeless the next.
But if Congress and the White House fail to act on the fiscal cliff by mid-January, the financial markets may react poorly. This will prove that Washington really doesn’t understand its immense power to affect and dictate the health of the economy. It will also signal that the fiscal cliff will just be the beginning of a year’s worth of unresolved budget and tax battles.
The debt limit is what worries markets the most, since failing to increase it means the Treasury Department cannot pay its bills or its bond holders. It could also prompt a ratings downgrade.
Wall Street analysts and economists predict that, in both the fiscal cliff and the debt ceiling negotiations, calmer heads eventually will prevail. Still, that doesn’t make the D.C. political complex and New York financial community cozy bedfellows just yet.
As long as Washington policymakers remain wedded to political ideology and positioning instead of facing the country's big economic issues, New York will never truly get its sister city down south.
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