A wide gap separates Wall Street, Washington on debt fight

A wide gap separates Wall Street, Washington on debt fight

Wall Street firms may be on the edge of a financial calamity and most don't know it, say analysts tracking the debt-ceiling faceoff in Washington.

any market players expect the White House and Congress to come to a deal to boost the debt limit beyond its current $14.3-trillion cap. But others in Washington say chances are high that an agreement won't be reached before the Aug. 2 deadline, when the Treasury Department predicts it won't have enough cash to pay all of its bills.

If the deadline passes with no deal, stocks and other assets could take a pounding, much as they did after Congress' initial rejection of a massive bailout in September 2008. The Dow Jones industrial average plunged 778 points on the vote, its largest one-day point drop ever.

Many on Wall Street don't see that happening. Robert Tipp, chief investment strategist at Prudential Fixed Income, thinks the odds that an agreement isn't reached by the deadline are less than 1%. "We're guardedly optimistic," he says.

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However, Stan Collender, an expert on federal fiscal policy, puts the odds at 50%.

"Wall Street has completely priced in the likelihood of a deal," says Collender, a budget analyst at Qorvis Communications in Washington. "That's very dangerous because they don't seem" to have prepared ahead of time.

While money managers view the debate through the lens of the markets, elected officials keep their eyes on the views of those who put them in office.

Tea Party Republicans in the House say they were elected to get control of the soaring federal deficit.

"You're asking a big chunk of elected officials to vote against the will of their constituents," says former Delaware senator Ted Kaufman, a Democrat. "Now we are less than two weeks away from requiring the House and the Senate to pass a bill" that many Americans may not support.

He puts the odds that the government fails to act by Aug. 2 at 60%.

The government could reach a solution at any moment. Earlier this week, a bipartisan proposal surfaced to cut the deficit by an estimated $3.7 trillion over 10 years. President Obama backed the plan, which, if approved by Congress, could lead to an agreement on boosting the debt ceiling.

Elected officials may need to be shocked into action. While some members of Congress, including Rep. Michele Bachmann, R-Minn., say they don't expect the market to unravel if the debt ceiling isn't raised, a market selloff could spark a deal.

Indeed, that's the same scenario that played out on Sept. 29, 2008, when the House defeated a $700-billion bailout of the financial system. After the stock market tanked, the House passed the bailout.

Wall Street complacency could explain why a deal hasn't been hammered out already, says Mark Thoma, a professor of economics at the University of Oregon.

"I'm a little bit surprised that financial markets aren't sending a stronger message," he says. "If they were, perhaps an agreement would have been reached quicker."