Market News

October 10, 2013  Thu 8:24 AM CT

The stock market craves certainty, decisiveness, and confidence. It hates uncertainty, waffling and the unknown.

So when President Obama acts decisively and appoints a candidate who is nearly universally liked, Janet Yellen, as Fed chair, the market reacts positively. It shows you that Washington may not be totally dysfunctional. It is reminiscent of when government worked, and someone as popular as motherhood and apple pie gets appointed to the highest financial office in the land. Sure, Washington is poisonous enough these days to question Yellen, as well as motherhood and apple pie, for that matter. But I believe that all three have good ratings and that she will pass Senate muster.

Unfortunately, the appointment of Yellen seems like a sideshow, kind of like "Our American Cousin," a play that Mrs. Lincoln might have liked if it were not for the fact that President Lincoln was assassinated while he watched it.

The real issue is the debt default and, sadly, this has become one where the odds seem to be growing that the non-talks will stay non-talks right through the Treasury secretary's drop-dead date of Oct. 17. Sure, we've been heartened today as we get one more whiff of conciliation, perhaps some talks between the House leadership and the president.

But follow the arc of this whole thing. We were thinking just last week that a default is as unlikely as a meteor hitting Washington. Now I think the odds are about 20 percent that it does hit the capital given how forceful both sides are about not talking to each other, not unlike what the president and speaker said earlier this week.

Twenty percent doesn't mean the event is going to happen, especially if there is anything to these whispered talks; I am saying there's an 80 percent chance that talks work. But a 20 percent chance of default means that you have to plan that it could happen. And the odds increase by the day when you have a game of chicken happening that something just goes wrong--the Buzz Gunderson/"Rebel Without a Cause" issue I alluded to earlier.

Remember, the people in government were looking at Lehman Brothers before it fell and, frankly, they figured that someone had a solution. Someone was going to buy the company--Barclays or the Koreans. Everyone in government was confident that one or the other would buy it, but no one did and we had the calamity to end all calamities.

Until this calamity.

So what will it look like? First, we had a great insight from Mark Patterson, a senior fellow at the Center for American Progress and a former chief of staff of the Treasury Department, when he appeared on CNBC's "Squawk Box." He explained in English that, while the Oct. 17 deadline isn't hard and fast, it is the day the Treasury can no longer guarantee that all the nation's bills would be paid. At that point it is possible, he explained, that all payments will get a haircut or that that some will be delayed, or that the Treasury must pick and choose what to pay and what to ignore. logoThat, frankly, is a horror show. As the month goes on with no new debt issued, those stopgaps won't work. He also emphasized that the Treasury's till is a lot like a bank account for any business. You don't want it to run as low as it is going to become on Oct. 17, and you certainly don't want it to run out entirely.

Plenty of Republicans apparently think that the whole thing's a charade and there's plenty of money kicking around for what matters, to which I say: How can that be? If that' the case, why do we need to ever raise the debt ceiling? And who is to say what we need to pay? After listening to Patterson, that sounds like a total disaster in the making.

What do we do, cut the size of Social Security checks? Only pay the interest on the five-year note? Cut back the Air Force because we aren't at war? Pay some doctors but not others? That doesn't sound responsible to me. What lesson does it teach, not to pay your bills, anyway? Why should I pay my bills if the government's not paying its bills? To heck with all bills!

For a moment, let's deal with the reality of what happens with the actual event. How do we know what it will look like? We are fortunate enough to have a terrific default roadmap put out by Michael Cembalest, the brilliant "Eye on the Market" editor at J.P. Morgan.

Now, you may sneer that he's a Wall Street capitalist from the House of Dimon, an international man of intrigue or first-class scofflaw, but Cembalest is someone with tremendous insight about world events and he correctly told you that Europe was going to collapse. Plus, he is a deficit hawk--certainly more than most of the GOP that claim they are deficit hawks--because he would cut entitlements. And I bet if push came to shove, most of the GOP that wants to default wouldn't because you don't get re-elected, even in a safe radical right district, if entitlements really are slashed as he would like them to be, at least over time.

Cembalest points out that if you trigger even a technical default, you could have a liquidity event that would force job cuts and tighten credit, particularly for small business and medium-sized businesses, that, ironically, the GOP is always saying it stands for. You could see crimping in retail sales and auto sales, too. That sure sounds like a recession to me. Cembalest writes that you could expect all of these terrible events to happen within two to six months--truly a shame given the fact that we are simply unwilling to pay our bills, not unable to.

Obviously, we are still in a position to avoid all of this. And if we do, you could be in a position where the economy could roar out just a few quarters from here, although the shutdown itself is really starting to slow the economy and crimp confidence in its own right.

I am not a political guy. I am, however, schooled in the ways of Wall Street, and we know that jobs were coming back and that the world was getting stronger before these talks got so bogged down that we have to put a percentage on the chances of default.

The just-released Fed minutes make it clear that the Fed was split between those who saw the data getting better and those who, clairvoyantly, thought we might have an off-the-rails debt-ceiling discussion. Thank heavens for the latter clique, of which Janet Yellen is certainly a charter member, because we may need the Fed to buy hundreds of billions of dollars' worth of bonds if bondholders want to dump their Treasuries, and rates would spike even ahead of a default.

Still, just another sideshow. Unless President Obama can figure out a way to have a non-negotiating negotiation (after all, he has said he won't negotiate), the only thing that matters is the binary-default/no-default discussion. And as long as default is on the table, there's the likelihood that we simply don't negotiate until we default--and then who the Fed chief is won't really matter, will it?

Yeah, we need a forceful president, but we need him to be forceful on the debt ceiling, not just the selection of a Fed chief--and that's what can break the morass currently gripping the market immediately after hope of a debt-ceiling deal fades.
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