Will Supercommittee failure spook markets?

Will a supercommittee failure now on the horizon spook markets?   Ever since the debt ceiling debacle in early August, the new supercommittee was supposed to be the ultimate answer to the gridlock in congress.

However, sources that have been close to the process over the long haul quickly recognized and predicted that the supercommittee may not be so super after all.  Predictions came fast that a supercommittee failure was as likely as congress’s failure to raise the debt ceiling in early August.

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How can that be?  After all, congress gave them the job they could not do before, but this time they added some of the most severe  financial and socially significant consequences ever placed on a committee.   If a supercommittee failure came due to a deadlock and inaction, automatic, and significant spending cuts would occur.

Now the time is at hand, the deadline for the supercommittee to recommend where to cut billions and how much to cut each program is at hand and they are deadlocked.     Markets will not react favorably if the deadline passes and no agreement is reached for at least two reasons, even in the face of automatic spending cuts.

–  If there is a supercommittee failure, domestic and international markets will see yet another failure on the part of government to address and solve serious financial issues.    If the highest levels of government cannot solve government  problems,  who will?  Markets will react unfavorably to what will be considered “Strike two” on the issue.

–  Ensuing to such a supercommittee failure, markets will simultaneously realize that bond rating agencies, Moody’s and Standard and Poors will also react unfavorable to the supercommittee failure and this will be factored into their future U.S. Treasury ratings.

Moody’s has already downgraded U.S. treasuries for the first time in history in 2011.     The government disagreed vehemently with their decision.   However, further U.S. government failure and inaction on U.S. deficit problems will weaken the government’s argument and position.

–   Most ominously,  some politicians have already begun quietly whispering that in the face of the feared supercommittee failure the legislated automatic spending cuts they created cannot happen and must be undone prior to them taking effect.

If this took place, the consequences may be worse than just letting     the cuts happen.    It would be amongst the most visible example in recent times of the failure of government and the failure to solve the country’s most severe fiscal problems by any reasonable measure.

The bond rating agencies, Moody’s and Standard & Poors would react most unfavorably to this scenario.   Moody’s and Standard & Poors has already indicated that they are not alarmed at the prospect of a supercommittee failure due to the automatic spending cuts in place if the committee is deadlocked and cannot come to an agreement.

The bond rating agencies, as most everyone else, thought that this time this committee would force itself to succeed and come to a compromise with elements that both sides vehemently disagree with.   This is the thinking because the automatic spending cuts, many of which they see will be worse than the cuts they cannot agree on now.

If politicians really break their promise, legislation and law regarding these automatic spending cuts in the face of a supercommittee failure, markets and bond rating agencies will surely react extremely unfavorably.   Markets would decline over time.    The most major negative consequences would occur in the 1-3 year range.   If bond rating agencies downgrade U.S. treasuries yet again, markets would decline most for fear of the long term impact of one or more ratings downgrades.

It seems that the very real prospect of the worse alternative to a supercommittee failure is not enough to spur agreement on less painful choices now.

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