Sunday, January 24, 2010

Uncertainty: Wall Street's Nightmare

Last week, the stock market fell 4%. Although somewhat disappointing earnings announcements were part of the reason, politics were the driving factor. Republican Scott Brown's surprise win as senator to replace Ted Kennedy was predicted by some to be positive for the stock market. Wrong. As soon as the Obama administration realized that it had been ambushed, it reversed course on financial regulatory reform, wheeled Paul Volcker out of the closet where it had been hiding him, and aimed the heavy political artillery at Wall Street. Stocks fell away at the end of the week, as renewed vigor for increased regulation and taxes implied moderation of future corporate earnings.

Political disarray is increasing. Democratic discipline, not exactly Prussian in the best of times, is evaporating fast. More and more senators are announcing their opposition to the renomination of Ben Bernanke as Fed Chairman. He must be reconfirmed by midnight, Jan. 31, 2010, or he ceases to be Chairman (and becomes an ordinary Fed governor). Frenzied headcounts indicate over 40 uncommitted senators. Considering that Scott Brown won in a last minute wave of populist insurgency, it's hard to predict what will happen. Republicans, smug over their guerrilla victory in Massachusetts, have put themselves in a bind. Bernanke is closely linked with Alan Greenspan and his Wall Street-centric outlook and policies. A vote for Bernanke is a vote to continue massive government subsidized profits and bonuses for Wall Street. A good case can be made for re-confirming Bernanke. But it's harder to make in the face of large numbers of angry people waving pitchforks.

If Bernanke, a George W. Bush appointee, isn't re-confirmed, President Obama can choose his own nominee. He isn't likely to choose the usual suspects--Larry Summers or Tim Geithner. They're too easily linked to policies favoring Wall Street. Christina Romer, Chair of the Council of Economic Advisers, is a possibility. She is less well-known in official Washington and therefore presents a smaller target for confirmation proceedings. Although she is seen as neo-Keynesian, anathema among the laissez-faire, a populist insurgency demanding job creation might endorse big government that helps ordinary people instead of Wall Street. And if Romer doesn't vet well, expect another nominee who won't cater to Republican preferences.

The Fed Chairmanship problem isn't exactly a win-win for Obama, since he re-nominated Bernanke and rejection would leave some splatter on him. But it's a lose-lose for the Republicans. It they support the Wall Street-subsidizing, money printing Bernanke, they offend the mob. If they vote against Bernanke, they'll face a Democratic nominee whose proclivities may match Bernanke on the monetary front and exceed his on the regulatory front.

The same dynamic operates with the President's call for more stringent bank regulation. If Republicans oppose it, they'll be painted as running dogs for the big banks that the mob detests. But supporting increased regulation only imperils a traditional Republican bulwark.

The President has just announced his support of a bipartisan deficit commission to develop ways to combat the federal deficit. This proposal, sponsored by Republican senator Judd Gregg (R-N.H.) and Democratic Senator Kent Conrad (D-N.D.), presents another dilemma for Republicans. The populist insurgency has demanded control over the deficit. With current and projected deficits as large as they are, the commission will have little choice but to recommend tax increases as well as spending cuts. More heresy looms in Republicans' futures.

All this leads to uncertainty on Wall Street and in corporate America. Uncertainty is bad for stock prices. It's harder to project corporate earnings when government policies are in flux. In many ways, businesses and especially Wall Street, can do well regardless of what the rules are, as long as the rules are clear and predictable. When federal marginal income tax brackets were 90% (as they were during and just after World War II), Wall Streeters made good money selling tax shelters. When the Glass-Steagall Act prevented commercial banks and investment banks from operating in the same corporate structure, investment bankers nevertheless got monster bonuses--it was commercial bankers, ulcerated with envy, who pushed for the repeal of Glass-Steagall. But when the rules are vague and likely to change, and members of both parties become internal dissidents, stock prices waver.

As stock prices fall, so do the values of 401(k) accounts across the nation. This portends more instability. The New Populism is really the Great Unalignment. There's no way to know where the outrage will flow. Neither Democrats nor Republicans can count on the nouveau insurgents. The anger Republicans surreptitiously fueled with their quiet funding of Scott Brown's campaign could easily boomerang against them. President Obama, who snidely sniped at Scott Brown's truck, again revealed an elitism--now toward truck owners in addition to gun owners--that he needs to get over fast. He may not realize it, but he simply isn't in touch with the American middle class. Maybe it's because he's spent too much time around elites and elite-wannabes. Maybe it's because he has a burning drive to escape the modesty of his own upbringing. But he has this problem--and it's him, not his advisers, not his party. Maybe he should change the oil and filter in a pickup truck a couple of times. Maybe, once every week, he should have a hot dog and baked beans for lunch. Maybe he should spend a half an hour at a firing range with a 9mm semiautomatic, and then another half an hour with a .38 special. However he does it, he needs to deal with this disconnect. His Democratic colleagues on the Hill are scrambling for cover and they'll abandon him in a heartbeat if that's necessary to saving their hides this fall.

It's always been true that political friendships exist only in fair weather. But storm clouds have rolled in and it's likely to keep raining until the mid-term elections. The Democrats are likely to lose some seats. But they may gain others if Republicans start to believe too much in their own publicity (as happened in upstate New York recently). However things turn out in November, the continued uncertainty portends a tough year for stocks.

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