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Dispatch
January 2008 Unbound Atlantic Monthly
The presidential campaign has financial executives more concerned about who wins than they have been in years—or it ought to by Joshua Green What's Next for Wall Street?Here in Washington, there isn't much that can overshadow the presidential race. But the recent turmoil in the stock market that prompted the Fed's dramatic rapid-fire rate cuts and the forthcoming $150 billion stimulus package from Congress have managed to do the trick. Suddenly Washington is obsessed with Wall Street. It's a useful reminder of the broader relationship between power and money. If you're on Wall Street, now might be an opportune time to start thinking about Washington. This year's presidential election seems certain to have an even bigger effect on the economy than will the stimulus package and the Fed cuts—regardless of who wins. "From an investor perspective, the stimulus package is important in the short term," says Blair Levin, a Washington-based managing director for the financial services firm Stifel Nicolaus. "But the next president is going to have to tackle a variety of areas that will have a bigger long-term effect on the economy." It's not news that government action moves the markets, or that elections can be pivotal to certain industries. Wall Street consensus holds that oil, pharmaceuticals, defense, tobacco, and HMOs prosper under Republicans, whereas alternative energy, infrastructure, environmental services, and Freddie Mac and Fannie Mae do well under Democrats (who are strong proponents of government-sponsored mortgages). Two additional factors make this year different. President Bush has ignored huge problems, problems that a combination of fiscal and political pressures will compel the next president to tackle. And the differences between how Democrats and Republicans would tackle these problems are more pronounced than they've been in years. Big changes are coming—but what they'll be and whom they'll affect is wide open. "This election," says Kim Wallace, chief political strategist for Lehman Brothers, "will be more meaningful for the market than any we've seen since Reagan." Here's why. New administrations always attempt the biggest things first, when momentum is strongest and opponents are weakest. Clinton famously led with his economic plan, Bush with a record tax cut. Under typical conditions, Washington can process one, maybe two, big changes in any single session of Congress—but no more. (Clinton got his economic plan, but he didn't get health care.) However, next year will be anything but typical. The new president will take office against a background of looming entitlement problems, with Medicare tipping into deficit for the first time and Social Security peaking and beginning to decline. At least one market-moving big change—Bush's tax cut—is certain to be addressed because it's about to expire. And three more areas of similar scope, all with major implications for the economy, will compete for the next president's immediate attention. Problem: Bush's tax cuts begin to expire in 2010, pushing economic policy to the forefront. At stake is about $300 billion in annual revenue, and Democrats and Republicans hold sharply different views on what to do. "George H. W. Bush's and Bill Clinton's economic policies were so similar that, if you were looking at them on paper, you wouldn't notice that a Democrat had been elected in 1992," says Jason Furman, an economist at the Brookings Institution. "This time you definitely would notice." Likely Republican response: Initially, all the major candidates pledged to extend the cuts (though some, like McCain, did so reluctantly). Then, just recently, McCain and Romney rocketed well beyond Bush and proposed further big cuts in corporate and individual rates in an apparent attempt to impress Republican primary voters. Likely Democratic response: Under a Democratic president, all kinds of taxes could go up—marginal tax rates, dividend and capital gains taxes, the alternative-minimum tax, the "carried-interest" tax on private-equity profits, and possibly the estate tax would all be in play—collectively amounting to change on the order of Reagan's 1981 tax cuts. Who it affects: Just about everybody. Problem: 47 million Americans don't have it. If the presidential race has created one area of consensus among the parties (and some in the business community), it's that something must finally be done about uninsured Americans. What that might be varies widely between the parties. But even legislation that stops far short of universal coverage—such as allowing the government to negotiate drug prices for Medicare recipients or import them from Canada—could roil the markets. "Historically, no industry is more sensitive to elections than pharmaceuticals," says Alec Phillips, a Washington analyst who has studied the issue for Goldman Sachs. Likely Republican response: Tepid proposals from Romney and McCain to make health costs tax deductible. A Democratic Congress would push for much more. Likely Democratic response: Universal or near-universal coverage proposed by all major candidates. Who it affects: Health care accounts for 16 percent of GNP (and pharmaceuticals for about 12 percent of the S&P 5000), and any change to the current employer-based system would touch nearly everyone. "In large, structural ways, the shape of our entire economy will be in play," one hedge-funder told me.
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