As Dow tumbles, how much is politics to blame?

Dysfunctional politics, both in Washington and in Europe, is spooking markets worldwide. While perhaps not as dangerous as the economic dysfunction of 2008, it is still a concern.

With the Dow Jones Industrial Average down about 16 percent in two months, investment analysts are worrying aloud about the risk of a new recession, or even a full-blown financial crisis.

But there are big differences between now and 2008.

The most basic one is this: Back then, investor uncertainties revolved around the health of private-sector banks and a breakdown in private channels of credit to the economy. Today, the uncertainties are largely about politics – whether governments in Europe and the US are able to act in ways that restore private-sector confidence.

After taking a 4 percent dive on Thursday, US stock prices were relatively flat in Friday trading. But the Dow index is still down about 7 percent for the week, and stock markets in Europe have fallen even more.

Many economic experts say recession can be avoided. And the worry about a possible downturn is fueled partly by concerns about consumer activity that are distinct from the political debates in Congress or the German Bundestag. But a recent flareup of political dysfunction on both sides of the Atlantic has had clear ripple effects on the confidence of consumers and businesses.

Confidence 'eroded daily'

In the US, for instance, a Gallup poll index of economic confidence tumbled in July as Congress and the White House were wrangling over the terms of a bill to raise the nation's debt ceiling.

"The world is in a danger zone," World Bank president Robert Zoellick said Thursday, at the opening of the bank's annual meeting in Washington. "In 2008, many people said they did not see the turbulence coming. Leaders have no such excuse now. And dangerous times call for courageous people."

He said he still believes a recession in major economies is unlikely, but that "my confidence in that belief is being eroded daily by the steady drip of difficult economic news."

If political gridlock persists, damage to the wider economy could grow worse.

In Europe, doubts center on the ability of euro zone nations to stave off a sovereign debt crisis. Private sector banks would face steep losses if high-debt nations like Greece and Portugal can't pay their loans in full.

The US government doesn't face such intense fiscal pressures. And American politics aren't complicated by Europe's problem, the need for multiple nations to agree on plans for bailouts and austerity. But in the US, as the Gallup indicator suggests, the rifts between Democrats and Republicans can affect overall confidence.

Prospects for new legislation to boost job creation, for example, are clouded by the partisan divide. More ominously, the chaos of a so-called government shutdown is possible starting barely a week from now, if the two sides can't come to a funding agreement as a new fiscal year begins.

Ideological differences over what to do are part of the problem, as is election-oriented maneuvering. President Obama has blasted Republican House Speaker John Boehner (R) of Ohio for taking a "my way or the highway" position opposing tax hikes. But the president has recently laid down his own ultimatum, saying he'll veto any deficit bill that cuts Medicare without raising taxes on high-income Americans.

"Europe, Japan, and the United States must act to address their big economic problems," Mr. Zoellick urged in his public remarks. "I know well that ... means honest and difficult discussions with parliaments and publics. [But] delay will narrow choices and make them harder and more costly."

Growth in advanced economies have lagged behind forecasters' expectations this year. A range of factors can help explain the economy's recent rough patch – from the impact of high oil prices early this year to the spillover effects of Japan's earthquake and tsunami. But many economists say the political challenges in Europe are an important added headwind.

Lingering effects of 2008

Back in 2008 and 2009, the US government moved aggressively in efforts to quell a financial crisis, which was spawned by the large mortgage-related losses at commercial banks and investment firms.

But that resulted in a big jump in the federal government's own debt. That's a pattern typically seen in such crises, as governments experience falling tax revenues even as they ramp up spending on bank bailouts, stimulus efforts, and covering recession-related costs like unemployment insurance.

With this pattern visible in the US and other nations, governments are running close to constraints on their ability to run deficits in efforts to stimulate economic growth.

Meanwhile, private sector banks still have their own troubles.

The credit-rating firm Moody's lowered its grade on Greek banks Friday. And earlier this week, Moody's downgraded several large US banks, saying they would be less likely to get government assistance in a new crisis.

All this doesn't mean that government policy failures will hang like a millstone on the economy in the months ahead. Some economists note that the downdrafts in financial markets themselves could prod nations to deal more forcefully with their challenges.

But for now, at least, concerns about the public sector are running high among investors, consumers, and employers alike.

“With the current, anemic economic conditions, the unemployment rate will remain consistently high and tax receipts will remain low unless the focus shifts to long-term policies and economic growth,” Business Roundtable president John Engler said in a statement Monday.