The Washington PostDemocracy Dies in Darkness

Wall Street isn’t that worried about the fiscal cliff. Is it savvy or stupid?

There are a mere 225 miles of road connecting the U.S. Capitol and Wall Street. To judge from the tone coming from the nation’s political and financial capitals the last few days, however, it may as well be an ocean.

Over the past week, President Obama and House Republicans have made their initial offers on resolving the fiscal cliff—plans to prevent an austerity crisis of tax hikes and spending cuts from taking effect Jan. 1—and each side issued a deep-throated chortle at the other’s offer. Much of this is the inevitable posturing that is a necessary prelude to true deal-making. But only four weeks before the austerity crisis sets in (and with a Christmas holiday wedged within that four weeks), it amounted to lost time and gave no sense that any real negotiating had begun.

On Wall Street, financial markets are acting as if there is nothing to worry about. For all the breathless headlines about stock market reaction to the latest comment from the president or Speaker John Boehner, the market is essentially unchanged since the election, and moves have taken place in a relatively small range. The VIX, a measure of expected future market volatility, is far, far, below its levels of just this past summer, indicating no great worry that wild market swings are coming.

Beyond the financial world, business leaders and ordinary Americans are similarly confident. “I came out of this meeting optimistic, extraordinarily optimistic, that Washington broadly understands the importance of getting something done,” said Joe Echevarria, the chief executive of Deloitte LLP, after a meeting between CEOs and President Obama last week.

The Wall Street and CEO crowds are attempting to be savvy in their reading of Washington. They know that it takes a lot of huffing and puffing and posturing and jockeying just to get the point where any real negotiating can happen. But the question is whether that savvy has turned instead into complacency. Many smart Washington observers think so.

“Wall Street and Washington are different worlds and speak in different languages,” said Chris Krueger, a political analyst at Guggenheim Partners, who works, in effect, as a translator between those languages. Krueger thinks there is only a 30 percent chance of a deal being in place before Dec. 31, and that it is more likely that the talks will last at least a few weeks into the New Year, with effects on markets that are hard to predict with any precision but are almost sure to be negative.

Krueger’s pessimism is widespread among insiders, the former White House staffers and Capitol Hill aides who have been through dozens of these negotiations and seen them up close. They know that the effects of going off the fiscal cliff, while surely damaging to the economy, are not likely to cause the kind of global financial meltdown that could have resulted from the U.S. debt default that would have happened absent a deal to raise the debt ceiling in August 2011. It could be quite bad for markets and the economy if taxes rise on Jan. 1, but not an all-out catastrophe (at least until the nation hits the debt ceiling again in February or March). That allows the negotiators some wiggle room.

The basic question is who is judging the political temperature better: Those at a healthy remove who know that these things usually work themselves out, if at the last possible minute? Or those who are closest to the action, who see little visible evidence that a deal is reachable by the end of the year?

Here’s the thing: They both could be right. It may be that the thing that will finally force the parties to negotiate in earnest will be increasingly desperate calls from supporters in the business community, or a few hairy days on the financial markets, of 5 or 7 or 9 percent declines.

What’s going on right now between the negotiators is Kabuki theater. But what markets and corporate executives may not understand is that they are actors in the play as well, not just the audience. Their role is to be a sort of forcing mechanism of their own—only when they start to panic will there be the pressure on lawmakers to take some hard votes.

Considering that an ultimate deal will likely require Republicans to vote for higher taxes and Democrats to vote for cuts to entitlement programs -- policies that each side finds to be anathema -- it may take a gun to their heads of flailing markets and economic disruption to persuade each to take such unpleasant steps.

Whether that takes place in late December or January, and whether even a temporary dive off the cliff causes any lasting economic damage, are the open questions, and for those there is not yet an answer.