The New York financial world sits just a four-hour train ride from Washington, yet the distance has seemed much longer in the last few weeks as politicians have parried over the fast-approaching fiscal cliff: that noxious mix of tax hikes and spending cuts scheduled to take effect in the New Year.
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. Yet, cliff diving seems potentially imminent unless the Senate and White House agree to a deal within the next 24 hours—and manage to also pass it through the Republican-controlled House.
“All they need is political will,” says Sean West, director of Eurasia Group's United States practice.
Two Goldman Sachs analysts have wisely called the 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 recent Goldman Sachs research note.
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 small-bore 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. 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, but it’s unclear how kind the markets will remain if the two sides fail to reach a deal by the stroke of midnight on New Year’s Eve. Last week ended with the markets down roughly 2 percent, with the Dow experiencing its biggest losses in over a month.
Investors and consumers increasingly are concerned that Washington’s dysfunction will plunge the economy back into a recession, as the Congressional Budget Office has estimated could happen as part of a cliff dive scenario.
Failure to reach a deal would also prove that Washington does not understand its immense power to affect and dictate the health of the economy, and it would signal that the fiscal cliff will be the beginning of a year’s worth of unresolved budget and tax battles.
Next up: the debt ceiling, which is far, far scary to Wall Street. The debt limit worries the 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 predicted late last week that calmer heads eventually would prevail. Still, that doesn’t make the D.C. political complex and New York financial community cozy bedfellows just yet and time certainly is running out.