“I think this time is different. I think they (Wall Street) should be concerned.” — Barack Obama
Wednesday afternoon, President Barack Obama sat down with CNBC’s John Harwood to discuss the government shutdown, the next debt ceiling debate, and other pertinent topics. Obama’s warnings are very real, and we’re taking notice.
Government Shutdown
The government shutdown remains top of mind since it occurred earlier this week, and it continues on with no clear end in sight. President Obama made a fiery speech Thursday morning blaming House Speaker John Boehner for not allowing a vote on the issue in the House of Representatives. Regardless, the primary issue remains that certain members of the Republican Party would like to repeal the Affordable Healthcare Act while Democrats will not concede on the issue.
As we discussed previously, we suspect the economic impact of the shutdown will not be completely devastating, and it might simply shift economic growth rather than eliminate it. Debate remains heated, but we think a resolution will surface in this issue, particularly if healthcare exchange usage remains healthy. Even though many claim to dislike the new healthcare regulations, exchange websites were consistently down and received millions of unique visits during the first days of operations. If the Affordable Care Act is popular, or even, dare we say, works, it will no longer be politically expedient for the two parties to quibble over it.
The Big Threat: Default
Though the government shutdown hurts and is far from ideal, the economy can easily muddle through the issue if it doesn’t last long. President Obama, however, warned of what we think is the more pressing issue: the debt ceiling.
We’ve seen this story before a couple years ago: the two parties could not come to a compromise, pushing the government to the brink of default, which damaged the country’s formerly-pristine credit rating.
Though the Treasury is doing everything in its power to delay the inevitable, the debt ceiling will likely be reached on October 17. At this time, we see little reason why those opposed to raising the debt ceiling will alter their thinking, and we think there is a larger non-zero probability (than before) that the government doesn’t come to a solution and subsequently ‘technically’ defaults. This larger non-zero probability is also captured within S&P’s AA+ rating, a grade below the top rating of AAA:
…the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011 (Source: S&P).
Not only would a technical default be an embarrassment on the global stage, but a technical default would also shake confidence in financial markets, cause interest rates to increase, damage consumer confidence, and truly have extremely negative economic consequences. President Obama said as much in his interview, particularly alerting Wall Street that the threat of default is very real. Last time around, we think the Street feared a default, but at the end of the day, the consensus was confident a solution would arise.
That doesn’t seem to be the consensus now. In fact, we think one of the reasons why Federal Reserve Chairman Ben Bernanke decided not to taper bond purchases was to keep the economy afloat in the not-so-unpredictable event of congressional incompetence.
Valuentum’s Take
A technical default may resonate with core Tea Party faction members, but the economic impact of the US defaulting on its debt would be borderline disastrous. And while a technical default is far from certain, the probability is certainly higher now than it was in 2011. We continue to hold protection in the portfolio of our Best Ideas Newsletter in the form of a put option on the S&P 500 (SPY).