US debt ceiling: On the Friday before Lehman Brothers went belly, up in September 2008, most investors made a critical miscalculation. Based on historical precedent, namely the rescue of Bear Stearns, they assumed Uncle Sam would ultimately come to the Wall Street firm's rescue. Now, on the last Friday before the US government faces a far larger cash crunch of its own, are global financial markets once again making a similar mistake?
True, investors have shown remarkable calm despite the inability of Congress to strike a deal that allows the federal government to borrow money to pay its obligations before an Aug. 2 deadline. Bond yields are at near-record lows. And despite some jitters, stocks are still above the trough they hit last month when investors were concerned about a default of tiny Greece. Even the dollar has held up above its lows of the year.
The reason is obvious: Washington has played debt ceiling politics plenty of times before. And, lawmakers always wound up agreeing to honor their commitments and extend the country's borrowing authority. That, of course, is the same sort of assumptive thinking that led investors in September 2008 to believe Lehman would be saved. Investors just weren't prepared for its bankruptcy the following Monday, which set off a market crash.
The US government is certainly no Lehman. But the political environment is dramatically different than it was the last time Democrats and Republicans faced off over budgets. The Tea Party wing of the GOP is zealously focused on cutting spending. Some of its adherents are convinced that can only take place in a crisis.
Based on history, the odds favor an agreement of some kind before the Treasury runs out of money. That's why markets haven’t flinched much. Investors are confident the past will be repeated. But Lehman's unexpected unraveling should be a reminder of the danger in relying too heavily on articles of faith.
