Why It's Good News When Obama Sinks the Markets

Includes: DIA, KBE, QQQ, SPY
by: Rick Newman

What a buzz kill. After a booming start in 2010, stocks have reversed course, thanks largely to President Obama’s draconian new plans for taxing and regulating banks.

We should be thrilled.

Not because of populist retribution against elitist bankers. That’s another matter altogether. But think for a moment of the usual relationship between Washington and Wall Street. They’re not supposed to be partners. They’re twin power centers that move in parallel when things are good, but more often, compete for primacy. Part of Washington’s job is to police Wall Street, and part of Wall Street’s job is to outsmart the authorities. Tension is a natural part of the interplay.

This dynamic went haywire during the financial crisis. It began with the Bear Stearns bailout in March 2008, when the Federal Reserve intervened in a market event mainly to “reassure” the markets and boost confidence. When the government gets deeply involved in the so-called free market, that signals a big problem. Stopping a run on Bear may have been the right thing to do, but it created unintended consequences that contributed to the Lehman Brothers (OTC:LEHMQ) collapse and other momentous events six months later.

In the fall of 2008, the government treated the stock markets like a hysterical child that needed to be calmed, no matter what. Several bailouts were hastily orchestrated over the weekend, to minimize the dreaded uncertainty by the time the Asian markets opened on Monday morning. It didn’t work. The markets plunged anyway, leading to the dubious bank-bailout program and many other desperate moves meant to reassure investors and stop the panic.

Obama came into office as stocks were sinking toward a 13-year low—and a depression still seemed possible. His Treasury Secretary, Tim Geithner, meekly tried to convince investors that the feds had a plan—when they didn’t really, not yet. Geithner’s early flailing proved that the only thing worse than government intervention in the markets was government intervention that doesn’t work.

The markets finally bottomed out last March, and government measures finally helped. The Federal Reserve’s “stress tests” on big banks provided some transparency about their condition, improving confidence. The government’s capital injections into banks helped stabilize them. A smorgasbord of behind-the-scenes guarantee programs, asset purchases and other maneuvers may have been the most effective stabilizers. But all that government aid has also created an economy that’s addicted to federal subsidies and terrified of failure, one reason that voters are more skeptical than ever.

If the economy is really recovering, then the banks and other pillars of free enterprise need to prove they can walk without government crutches. Obama apparently believes they can. His bank bashing obviously has a populist tint, aimed at enraged voters, but it also signals an important shift: The government is no longer coddling Wall Street. That’s good news, and the more tension there is between regulator and regulated, the stronger the signs that things are getting back to normal.

If all goes well, this will be the year when the government retreats from its forays into capitalism. The Federal Reserve will reduce its support of the credit markets. The home-buyer tax credit will expire. Stimulus spending, enacted last year, will start to peter out. The government will reduce its guarantees of bank assets and maybe even get paid back by AIG, Citigroup (NYSE:C), General Motors and Chrysler. And the government will start acting like the government again, not like a conflicted Sugar Daddy.

It would be lovely if Washington and Wall Street held hands and convinced Americans that they’re going to work together for the betterment of the nation. Except that is has never worked that way, so why should it now? A good healthy battle over taxes and regulation, however, makes it feel just like old times.

About this article:

Problem with this article? Please tell us. Disagree with this article? .