Why we may need a stock market plunge to solve the debt ceiling crisis

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Wall Street is taking a no-worries attitude about the ticking time bomb in Washington that threatens to blow up the world economy. That might be a problem.

Debt ceiling-inspired selloffs have been almost nonexistent. The Nasdaq is still up by a staggering 22% on the year. And CNN’s Fear and Greed Index of market sentiment is nearing “extreme greed” mode.

No one wants to see markets panic, needlessly shrinking the 401(k) plans, nest eggs and college savings plans of millions of Americans. Unfortunately, there is a growing sense that a bit of market mayhem might be necessary.

“A selloff in stock and bond markets may be what’s required to get donors and voters to pound on lawmakers’ doors to stop the drama and increase the limit,”

News of that setback was greeted with a collective shrug on Wall Street. Stocks retreated from their highs but the Dow ended the day with a loss of just 109 points, or 0.3%. That’s not exactly going to get people to call their lawmakers.

In some ways, the calm mood in markets is acting like a feedback loop. Investors are betting it’ll all get taken care of. Lawmakers are in no rush because the markets are not freaking out. Rinse and repeat.

“Both political parties may need to see incremental market turmoil before settling on an agreement."

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Market selloff forced a redo on TARP in 2008

In 2011, the most serious near-default in American history, markets experienced volatility in the days and weeks before Washington reached a last-minute deal to raise the debt ceiling. Much more selling occurred afterwards as investors fretted about deep spending cuts and the unprecedented credit ratings downgrade from S&P.

None of this is to say markets are completely ignoring the debt ceiling drama today.

Beneath the surface, there are signs of concern. The cost to insure US debt has skyrocketed from earlier this year. And interest rates on Treasury bonds maturing this summer have surged as investors worry they may not get paid on time.

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‘Not enough worry’

“Final compromise is really hard. And it requires, for it to be truly bipartisan, someone or both sides to give more than they want."

“What worries me is there is not enough worry today,” said Ed Mills, Washington policy analyst at Raymond James. “I’ve long held the belief that DC responds when there is a crisis or a deadline. We have not necessarily agreed on a deadline. We understand there could be a crisis but we’re not yet at a crisis.”