The demise of the so-called Congressional Super Committee played out like clockwork: round-the-clock finger pointing in the days leading up to the announcement Monday that the committee has failed its mandate of trimming $1.2 trillion from the U.S. budget over the next decade.
This wasn’t supposed to happen. Virtually no one, least of all savvy Wall Street traders, expected a committee (super or otherwise) comprised of six Democratic and six Republican members of Congress to succeed where many others have failed.
What happened Monday is that investors are apparently -- and perhaps for the first time -- coming to grips with the consequences of ‘full sequestration,’ that is the $1.2 trillion in automatic budget cuts that are now required because the committee failed to agree on a plan of its own.
“Market focus will now shift to the fate of the expiring payroll tax cuts and unemployment benefits,” explains a note from Barclays Capital Research
In other words, investors are responding to the likelihood that payroll tax cuts and unemployment benefits that help boost businesses’ bottom lines and put money in consumers’ pockets will now probably expire as part of the automatic budget cuts.
Weighing just as heavily on investors’ minds is the threat of another downgrade of the U.S. by one of the credit ratings firms.
Earlier this month Morgan Stanley analyst Christine Tan warned of a 33% chance of another downgrade.
“If the super committee fails to reach a $1.2 trillion deficit reduction deal, if such a deal relies more upon accounting changes than real deficit reduction, or if congressional action lessens the impact of the $1.2 trillion automatic trigger, we believe this could potentially provide S&P with a pretext to downgrade the US further from AA+ to AA,” Tan wrote in a note to clients.
Bank of America Merrill Lynch analyst Ethan Harris was more specific: “The credit rating agencies have strongly suggested that further rating cuts are likely if Congress does not come up with a credible long-run plan. Hence, we expect at least one credit downgrade in late November or early December when the Super Committee crashes.”
In August S&P downgraded the U.S. based almost solely on the fact that Congress seemed unable or unwilling to cooperate and compromise on a serious plan to reduce the staggering level of U.S. debt.
Back then it was negotiations to raise the U.S. debt ceiling, the culmination of which was an ugly agreement that created the Super Committee, in effect putting off any hard decisions and instead tossing them into someone else’s lap. S&P took notice and promptly issued its downgrade.
The concern is that this most recent high-profile effort, which also ended in failure, could prove similarly frustrating to ratings agencies awaiting a credible effort by the U.S. to get its fiscal house in order.
Another factor dragging down stocks Monday is the reality that even the automatic cuts brought about by the committee’s failure aren’t likely to go into effect until well after the 2012 elections, perhaps as late as 2014. And that’s if those cuts -- especially ones that impact powerful industries such as the defense sector, not to mention popular entitlement programs such as Social Security and Medicare -- survive the intense scrutiny by lobbyists as they make their way through Congress.
Add the ongoing European debt crisis to investors’ heightened sense of frustration toward political gridlock in the U.S. and Monday’s selloff was easily explained.