Role reversal as Wall Street blames Washington for economic woes

A number of economists and financial managers say Washington is making the volatility on Wall Street worse, when it should be acting as a calming influence.

Usually, Washington points the finger at Wall Street for some financial tomfoolery. But now some Wall Street commentators say Washington bears some responsibility for the wild markets over the past several weeks.

They argue the wild swings started right after Congress finished wrangling over extending the federal debt ceiling. Then, after Standard & Poor’s downgraded the credit rating for US debt because of the politics involved in reaching any future agreement, the markets got really extreme – dropping 623 points in one day. The result: many investors say Washington’s behavior had something to do with raising the level of angst.

“I talked to a lot of financial consultants and investors on a one-on-one basis and most feel the way it was played out was almost Machiavellian, and it created a lot of uncertainty and volatility that was not needed,” says Fred Dickson, chief investment strategist at D.A. Davidson in Lake Oswego, Ore. “There is a considerable amount of blame resulting from Washington’s misbehavior.”

Of course, Washington was not the only reason the stock market rose and fell by triple digits for five consecutive days. (On Monday, the market was somewhat less volatile, and the Dow Jones Industrial Average gained 213.88 points, another triple digit move, as it continued a rebound that started late last week.) The volatility coincided with rising worries over whether some European nations might default on their debt, causing a new banking crisis. And the Federal Reserve did not help investor confidence when it said it expected slow economic growth for the next two years.

“You can always blame someone somehow,” says Sam Stovall, chief investment strategist at Standard & Poor’s in New York. “In this particular case, where you have a potential for an impasse, you have the government impeding rather than leading.”

The government currently seems to be in a gridlock mode, with the Republican-led House reluctant to raise taxes, and the Democrat-controlled Senate blocking attempts to overhaul entitlements.

“At least Congress can’t pass anything that would add to the debt, but because of the congressional impasse, it does not appear that the government will come up with any creative solutions anytime soon,” says Mr. Stovall.

Gridlock in Washington has not always been kind to investors, says Stovall. He charted the average annual price increase for the S&P 500 from 1900 through July 28, 2011. During periods when the Congress was divided, he found that the increases were less than half of what they were when one party held both Houses of Congress as well as the White House.

Since 1900, for example, the S&P average rose only 3.2 percent per year when Congress was divided, Stovall found. So far this year, the S&P average is down about 4.6 percent.

The recent debate over the debt ceiling left many of clients frustrated, says Frank Fantozzi, president of Planned Financial Services, a money-management firm in Cleveland.

They want some level of bipartisan agreement, he says. “They don’t mind a certain level of debate,” Mr. Fantozzi says. “They realize it takes a while for some legislation to come to fruition.”

Fantozzi says the S&P downgrade “set the tone” for the last two weeks of heavy trading. “In and of itself, it should not have created the turmoil,” he adds, “But given the problems with housing, the high unemployment, it was the straw that broke the camel’s back.”