Dow and Out?

What will Obama do when the markets don’t turn around?

When the markets began their kamikaze dive into investor confidence last September, most steely-nerve economists thought the basement for any eventual recovery was at worst 7,000 for the Dow.  All but one of the previous recessions had seen the market cut no further than in half when the bulls were replaced with bears and devoured stocks.  The exception to this recession rule?  The market crash of 1929 and the Great Depression.

Thus the markets fell further into fiscal madness when the Dow crossed the economist’s line in the sand.  With the Dow under 7,000 – roughly 50% away from the October ‘07 high of 14,000 - an oversold market sold further, dropping nearly an additional 300 points yesterday.  Throw in AIG showing a $61.7 billion loss despite $150 billion in bailout money, and one not only wonders when the bleeding will stop but how much more surgery Washington might demand.

Considering that the Administration is forecasting only a contraction of 1.2% in 2009 and whopping 3.2% growth in 2010, the political will to simply ride out a recession that is still taking it’s toll on stocks will be almost impossible to employ.  Regardless that the Fed predictions of a contraction of 1.6% to 2.0% in GDP pails in comparsion to the 4.9% GDP drop of 1974-75, Obama has placed too many of his political eggs into the Stimulus’ basket – which is precisely the problem.

The Administration might want to “literally drop-kick” the economy but can’t politically afford to punt if and when the balleyhooed recovery fumbles the snap.  Obama could plead for patience, especially given that his own rosey economic picture still contains a bleak image of 2009’s finances.  But AIG’s announcement complicates even that view, as former KvM contributor Doug Williams articulates:

That’s the key thing that distinguishes bailing out AIG from bailing out General Motors and Chrysler. We’re not bailing out because we’re worried about all the layoffs, or the loss of a key industry to overseas competition. We’re bailing them out because if they go down they could take our entire banking system with them. Not just your 401K, but your ability to get a loan – any loan. For anything. For the forseeable future. Multiply “you” by the factor of “and everyone else including businesses,” and you begin to see the scope of the problem.

That leaves Obama two major options – blame the stituation on Bush or further tinker with the market by more spending.  The former has a limited shelf life and the latter is already dangerously over leveraged.

While investors and Wall Street rightly fear that Obama will continue to play with the markets using regulations and Keynesian policies – noting that Obama’s first full month in office was the worst for the stock market since 1933 – there is a perhaps even more disquieting third option.  The Wall Street Journal half-jokes that Obama is running out of people to blame for the lack of a financial turnaround, but Obama’s political solution should the markets not conform to his centralized economy is simple – blame the markets themselves.

Candidate Obama talked frequently about the “ethic of greed” that created the economic turmoil – rhetoric he’s employed less since taking office.  But after spending trillions between the stimulus and the spending bill, not including the trillions spent on the bailout last fall, at some point the argument that not enough has been spent will fall a day late and a dollar short.  All that will be left then is to guard against the political failout from the failures of the bailouts.  It isn’t hard to imagine the media and Congress, stymied by economics, resorting to portraying the securities industry as a collection of Marie Antoniettes aloofly bemoaning the plight of the masses as they claim “let them eat derivatives.”

Such a move wouldn’t be novel – faux populists from either party have attempted to pit Wall Street vs. Main Street since the nation’s inception.  But increasingly unlike recessions past, more and more Americans are tied to the Dow’s “daily gyrations” in the form of IRAs, 401k’s and any other manner of investment.  While only roughly 20% of Americans own individual stocks, now nearly 60% are invested in the market as compared to 1980 when only 20% of the nation rode the ups and downs of the Dow.

Obama’s two best choices are to inject some real pro-growth measures into any additional stimulus moves or simply to do nothing at all and stop frightening the markets with his efforts to remake the country in his first 100 days.  He’s already proven that he won’t do the former and thus far looks like he’s just as reluctant to do the latter.