What if Obama Wakens the Balrog? Markets are Too Complacent on the Debt Ceiling.

This is market commentary, not politics.  The debt ceiling game of chicken could get seriously out of control a whole lot closer to the cliff than most seem to think.  With Obama driving it to the brink.  

The consensus on the Debt Ceiling debate seems to be “They will shout and scream and then work it out in the last few days with no major damage done.”  The consensus seems based largely on handicapping the House Republicans.  Obama is assumed to take his usual role as the reasonable, compromising, slightly wimpy actor in the whole drama.  And he might just stick to form.  But Obama has strong incentives to stir the pot, rile up the wackos, and take the whole thing to the brink.  Consider his position:

• He knows a “grand bargain” ain’t gonna happen.
• He’s not running for re-election.
• He IS trying to avoid lame-duckiness in the last two years of his term.  That depends on winning Democratic control of the House in 2014 (with a burst of pent-up policy making to follow).  Winning Congress in your second term goes against history (and recent gerrymandering).
• He needs massive turnout to have any chance of success.

If he chooses, Obama can use the Debt Ceiling to wake the Balrog – Senior Citizen voters  (Balrog clip below if you need reminding).  This doesn’t seem to be on the market’s radar screen.  

• All the debt ceiling commentary I see centers on risks to the Treasury markets.  That largely highlights the myopia of the current debate.
  • As an aside, the markets aren’t totally stupid.  They know this is not an actual default.  It risks huge disruption, but probably no lasting damage.
• No-one is talking about what happens if Social Security checks are seriously threatened, or actually suspended.  Obama can use the debt ceiling debate to maneuver the Republicans squarely onto the 3rd rail of American politics.
  • Obama stakes out the high road by taking an clear and (apparently) principled stand against negotiating over the debt ceiling.
  • The Republican play into his hands with political theater around “de-funding Obamacare.”  They get louder and prouder as time goes on, betting that only wacko-wing base voters are really paying attention to the show.
  • A few days before the whole government shuts down, Obama gets on national TV and explains that seniors citizens should plan for a cut-off of Social Security checks.  And Medicare payments.  And a possible disruption of their portfolio income.  And a potentially massive hit to the portfolios themselves.  Obama just needs to hit the right note of weary resignation (see Daniel Day Louis in Lincoln).  And the guy has gotten pretty darn good at weary resignation lately…
  • Cue one (very grumpy) Balrog bashing at the gates of Congress.  With John Boehnor cast as Gandalf (expect he probably doesn’t come back stronger and less orange-y colored after falling into the fiery pit….)
• Obama would take some heat (mostly from Republican partisans who aren’t going to vote for him anyway).  But most voters will blame Congress and the (Republican) House.  
• That hands Obama the lever he needs to drive turnout in 2014.  TV ads about how Congressman X “Voted to Cut Off Your Social Security To Play Washington Politics” should do wonders to deliver engaged (and enraged) voters.  AND suppress turnout of less-partisan Republicans, who are already finding it hard to hold their noses and vote (especially since Sarah Palin).

When House Speaker Boehner promises a “whale of a fight” it seems clear that we WILL have a crisis.  And Obama does seem to see the no negotiations thing as a matter of principle.  So regardless of whether Obama takes the extreme tack or not, the likely outcomes are.

• Last minute passage of a “clean” bill by a majority of House Democrats and a minority of House Republicans.  This continues the de-facto minority-coalition-government that has transformed the US polity into a particularly dysfunctional Parlimentary system…
• A retreat by the House Republicans and passage of a “their own” clean bill.
• We actually go over the cliff.  That could turn out to be financial Armageddon, or a hiccup like last time around.  But it would almost certainly produce a whole lot of pissed off seniors Balrogging about.

I am mystifyied that House Republicans seem so enthusiastic about playing with fire.  I am also pretty disgusted with today’s Republican Party.  But neither are the point of this post.  The point is that the market is mis-positioned.  Not sure I will re-position my portfolio in response, but you should at least consider your own positioning.