On Political Brinksmanship And Stock Market 'Vigilantes'

Tyler Durden's picture

Despite the hope of the last day or two, policymakers remain, we suggest, as far apart as they ever have, with 'no news' simply that. An oversold bounce does not a fiscal cliff fix, and as BofAML's Michael Hanson suggests in his 'brief history of brinksmanship': "one lesson from the recent past is that market reaction has been an important mechanism to reaching compromise and forcing action." Unfortunately, he adds, as we have been quite vociferous about, that "history also shows that the equity markets have to sell off sharply before policy makers listen to the 'stock market vigilantes'." With some politicians still thinking going over the cliff might be their best strategy, it could once again take a sharp market sell-off to focus the minds of the negotiating parties. If we actually manage to go over the cliff, even if only for a brief period of time, a repeat of the TARP sell-off seems only too probable.


Via BofAML: A brief history of brinkmanship by Michael S. Hanson

Policymakers have recently made a habit of creating deadlines, thresholds and cliffs to force themselves to act. The result has often been severe market volatility around key decision dates. Markets may be in for yet another bumpy ride as US fiscal cliff and European sovereign debt negotiations continue. However, one lesson from the recent past is that market reaction has been an important mechanism to reaching compromise and forcing action. Unfortunately, history also shows that the equity markets have to sell off sharply before policy makers listen to the “stock market vigilantes.”




The fiscal cliff is the latest example of a brinkmanship moment — and a large one to boot. Japan just recently averted its own fiscal cliff scenario, and several budgetary challenges loom for peripheral European countries. Politicians appear to have learned from past episodes that these deadlines are useful negotiating tools. But a review of recent history suggests it is less the deadlines themselves than the negative market reaction as the deadline approaches — or goes whistling past without action — that actually forces some resolution.


Toss a damp TARP on it


The debate over TARP (the Troubled Asset Relief Program) is perhaps the canonical example of a brinkmanship moment where the market forced action. Treasury Secretary Henry Paulson formally proposed the TARP on 21 September 2008, and the markets started to rally a few days earlier on the news of the bailout plan. A contentious battle with Congress followed, as the Senate Banking Committee rejected the plan on 23 September. The House and Senate then worked to fasten a compromise, but that was rejected by the House on 29 September by a 205-228 vote, largely along party lines. The S&P 500 fell 8.8% on that day alone. TARP was finally passed after the third try on 3 October, but the damage was done. Markets continued to drop sharply over the next week, ultimately dropping more than 28% from when the news of TARP first leaked out. Equity markets sold off sharply in Asia and Europe as well.


Rolling European risks


Similarly, the sovereign and banking crises in Europe have resulted in a number of market sell-offs and spikes in volatility (Chart 1). In May 2010, market volatility again mounted as uncertainty preceded the adoption of the first bailout plan for Greece — the first of several. Additional market sell-offs occurred around other European policy debates, including setting up support programs for other peripheral countries and the establishment of the EFSF and ESM. Despite various actions by the ECB that soothed the markets (rate cuts, LTROs, OTM), the risk of additional brinkmanship in 2013 remains, as northern bailout fatigue meets up against southern reform resistance.




The debt limit debacle


TARP was the first scene in the multi-act tragedy that has been US fiscal policy over the past several years. Passing “continuing resolutions” at the last minute that avert a government shutdown, but only keep the federal government running temporarily has become the norm. In mid-2011, US politicians went to the brink over the debt limit, as conservative House Republicans toyed with the possibility of a default on US Treasury debt to get President Obama and Senate Democrats to accede to significant spending cuts. Again, the markets sold off sharply, helping cement the Budget Control Act of 2011. This act included the now infamous “Supercommittee,” charged with agreeing to a comprehensive, long-term deficit reduction plan. Instead, they agreed to disagree and fell into another threat point that was never meant to happen: the US$1.2tn automatic spending cuts known as the sequester. The markets again sold off in late November 2011 on that news. Other measures of uncertainty spiked as well (Chart 2), and have generally remained high.




Clambering along the US fiscal cliff


In all of these cases the market reaction — or threat thereof — helped to motivate policy makers to step back from the brink and find a solution. The same is likely the case, in our view, for the ongoing fiscal cliff negotiations — itself a construct of delays and manufactured deadlines. Once it became clear that the US election would largely return the status quo to power — the same folks who built the cliff — the markets sold off as they reassessed the risks around the cliff (Chart 3).



This past Friday, a meeting at the White House to start the cliff negotiations concluded cordially, pushing up market optimism. However, no policy decisions were reached, and news reports suggested that the two sides largely agreed to disagree for now on several key points, such as how to raise additional revenue as part of any deal. There is limited time to put together anything more than a down-payment on a bigger deal that will have to be negotiated further — and likely will have its own deadlines and triggers should an agreement remain out of reach.


Meanwhile, the recent market reaction demonstrates the risk of additional volatility as investors grow optimistic when “good news” on the cliff is announced. When talks stumble at a difficult stage of the negotiations, which seems inevitable given the distance that remains between the two sides, markets may again sell off. Moreover, every time the market reacts positively to even the lightest of positive news, the pressure on policy makers to reach a conclusion relaxes. With some politicians still thinking going over the cliff might be their best strategy, it could once again take a sharp market sell-off to focus the minds of the negotiating parties. If we actually manage to go over the cliff, even if only for a brief period of time, a repeat of the TARP sell-off seems only too probable.

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fonzannoon's picture

Okay lets see if we can spot a trend here BAC

"the markets sold off sharply, helping cement the Budget Control Act of 2011. This act included the now infamous “Supercommittee"

Now the markets have to sell off sharply to force the politicians to come together to eliminate all the cuts that the supercommittee agreed to.

Yeah this is not pure fucking insanity

Nobody For President's picture

This is NOT 'pure fucking insanity' - this is The United States of America's Fiscal Policy.

But perhaps I repeat myself.

TrustWho's picture

Insanity is about ready to get real. This so called fiscal cliff allowed the House to pass the last debt ceiling increase. Well, that debt ceiling increase has run its course.

How can any self-respecting person pass another debt ceiling increase? What can one negotiate once the other side has lied to you on past negotiations?

If they do kick the fiscal cliff can down the road, good luck raising the debt ceiling?

LawsofPhysics's picture

Just for you fonzannoon - "Beating expectations, all... the... way... down...".  Long anything the central banks cannot print or purchase with printed paper.

Sudden Debt's picture

I wonder in what year we'll learn about the loses for the ESM and EFSF now that France lost it's rating :)


Cognitive Dissonance's picture

The script is well known and faithfully followed. After the stock price/fiat drops off the end of the Earth management sweeps up all the dead bodies and conducts a show and tell, then buries the entire stinking mess in the back yard.

<So sorry bro. Better luck next time.>

Urban Redneck's picture

There is an odd serenity to cliff diving, despite the fact that it is potentially fatal...

CrashisOptimistic's picture

Remember back when governments didn't have much effect on the economy or markets?

Dr. Engali's picture

A drive off the cliff and market instability plays right into Obama's plans for nationalizing 401ks and IRAs. After all markets have proven that they are  too unstable to trust one's retirement to.  And the current system is more favorable towards the rich, and we can't have wealth creation in this nation....it just isn't fair to the poor.

fonzannoon's picture

Hs ZH posted anything about this Nationization plan? I know some guest posts have. I would think if there was anything to it (and I think there is) that ever remotely became mainstream the rush to the exits would be monumental. They would have to keep this an absolute secret right up until they go for it. I have a hard time with that one.

Cognitive Dissonance's picture

As long as the herd wants to think that it all can end well there will be no rush for the exits. When sentiment begins to change, meaning when (false) hope begins to die.........well..........banks will close on Friday and open under new rules on Monday.

That's how it has always been done. I don't expect them to go too far off script this time as well.

Nobody For President's picture

Giving an entire new meaning to 'Black Friday'.

glenlloyd's picture

Keeping it secret doesn't make it legal, then again it seems like the law can be circumvented. Regardless as to how hushed they keep it I think it would amount to a seizure and there would be a huge outcry about it. They will probably do it though at some point.

In the end the prosperity of the past has to be paid for, and in typical fashion it will fall on the shoulders of future generations whether they can deal with it or not.

Those past generations who believe their good fortune didn't come at a price need to rethink that philosophy.

jimod's picture

That fool had no plan past getting re-elected.



Dr. Engali's picture

Don't bet on it. They tried pushing for it in 2008 they will push harder now. They are already holding hearings.

SmoothCoolSmoke's picture

Off the Cliff.... the Bear's wettest of wet dreams.

CrashisOptimistic's picture

Somewhat, except that . . . what's going off the cliff?

Is it not sharply reducing the deficit and running up another $1T in debt?  Or is it sharply reducing it to, say, $600B and only running up that much debt?

jimod's picture

We should try the 600bn deficit over the cliff for a couple years, until the mid-term elections, instead of the 1.6tn on the perenniel edge of the cliff.

scatterbrains's picture

We havn't seen a sharp sell off with volume in this latest dip...



Zer0head's picture

looks like Margaret Brennan formerly (thankfully) of Bloomberg has scored on the Benghazi beat

"However, an intelligence source tells CBS News correspondent Margaret Brennan the links to al Qaeda were deemed too "tenuous" to make public"

JustObserving's picture

Stock market vigilantes?  They are as dead as the bond market vigilantes. The Fed controls every market.

Where are the vigilantes when APPL or FB can rocket 10% in a day - they are just fictional now.

They must keep the vigilantes alive to keep up the illusion of a market - just as they kept bin Laden alive from Dec 14 2011 to May 1, 2011 to maintain the phony war on terror.   Dead people can have a function more valuable than alive ones.  Eric Holder and Gary Gensler come to mind.


dracos_ghost's picture

Stock market vigilantes do exist. Except they are algos that last 100ms at a time. Anything longer than that is just nutty soothsaying. Silly humans, trix are for bits.

Savyindallas's picture

We also need a drug crazed psycho mass killer at some school to maintain the bogus war on drugs and the assault on the 2nd amendment. The banksters will never allow legalized drugs, and certainly will not abide by the record sales of guns and ammo.

IamtheREALmario's picture

The stock market and the price of individual stocks used to move in the opposite direction to the the majority opinion (now computers decide and react based on how they have been programmed ... to always make money). This has been taken as an axiom of market action. But why? What rational "free market" works in the opposite direction of the laws of supply and demand? None, obviously. The conclusion then is that the stock market is not a free market ... because it looks to be very rational. The only thing that people eductated in the public system need to do is throw away the false education and understand that price is controlled as a matter of policy and as a matter of benefitting those who run the system. It is a sham propagated by a myth.

So, when I see all of the pundits coming out and saying, "this or that has to happen for some fundamental reason" I think, oh reall? WHY?!? It will only happen if those who control price in this market want it to happen and the way they maintain the most control and collect the most money and property from others is to do the opposite of what a rational free market would do.

I do not trust that they will move the price of the market down, now that they have already given you a taste. The rational non-free-market action is for there to be a fiscal cliff and for the market to rise ... and then fall on the news of a (faux) solution to the (faux) fiscal cliff.

We shall see.

earleflorida's picture

'the 'fiscal cliff' is but a self-induced hallucination-- a jonestown jubilee without the happy ending? flighty as it sounds... for the safety of the proles left out in the cold!  propagated by the fabulous and infamous dc-institutions' asylum's nurse--'lady cuckoo's mc`ratched'... all for the criminally insane political scientist this forget me what-naught, beggar'd-thy-neighbor, debtors church of deadbeat riffraff? strange as it be, as if looking through padded mirror walls... the 535 inmates speaking not a verb, yet quietly telegraphing the mystics within... having not a one  psyche to be found... as if, it to is neither willing to give up a pound of its shadowy flesh, tirelessly thinking through in a rational upward-backwardation conundrum kinda-way?? why? why the 'cabal-bridge' failed...the fail-safe-- the safe fail'd! whilst, their release date be the usual 11th hour? thusly their tenure is set! the deed done,... as nurse ratched clocks out shy of the dreaded 11th hour just before high noon-- with a cynical wry smirk,...sheltering a hearty, heartfelt? smile within, with a devilish muted laughter ear too ear... just having preformed 535 successful frontal lobotomy's in less than a month is no feat left unrewarded says she, as she pulls a draw from a pint tucked tightly under her angelical cap!  saving the country for at least the holidays or even another 'god bless america's superbowl ... with plenty of mistletoe that a wet kiss bequeaths !?'

until 2013 all shall be but quiet days...   

disabledvet's picture

Equities are forward looking indicators therefore the problem with equities is that as they surge higher they are an indicator of higher prices or "debt monetization by other means." Aka "inflation" or "the ultimate tax." Equities could absolutely fall...to date however the USA has avoided both "the Japan scenario" and as well presented here the USA's own deflation during the Depression. I would argue we've avoided a 70's style inflation first off by lying about prices and by allowing Wall Street new ways to hedge against the perennial risk most notably through index funds. There is a point where declaring cash a valueless asset has consequences. Obviously 2008 was one of those consequences...still the system grinds on with "anything with a yield worth infinity." The question remains therefor "how long this infinity?" It is very rare for all asset classes to rise in unison. (Correlations approaching one I believe is term.) MANAGE YOUR FUTURES ACCORDINGLY.

Carl Spackler's picture

This is just the first Act of a larger drama.  The tax code can be changed, retroactively, any time next year.

No deal will be done in 2012...setting up ever more dramatic theater for 2013 (if politics is your thing).

Stay tuned.