Obama Gridlocked Is the Market's New Best Friend

Sept. 8 (Bloomberg) — Right wingers are in an uproar over President Barack Obama's plan to address school children this week.

Some find such a display of sanctimony by a federal official toward school kids inappropriate.

Yet this use of the bully pulpit is probably good for a different crowd: bulls. Market bulls, that is.

Preaching like a social worker takes time away from other things the president might be doing, including finding enough votes to make his health-care overhaul truly radical. Over the weekend the story of the school speech actually overshadowed the speech the president is planning this week on health care.

Everyone knows that government in action can terrify markets. What matters most is the quality of the initiatives. There are those that change the world. And there is "feel good" activity that substitutes for significant change.

This latter kind is almost the equivalent of inactivity. A Washington abuzz over a pep talk for sulky sophomores is a Washington that might leave the rest of the economy alone to grow. The stock market recognizes this, and acts accordingly.

It all might provide an explanation for the past year. Last September both the White House and commentators argued that a financial bailout would save us. That such a bailout would help the market recover went without saying. The bailout package passed in early October, auguring involvement of the federal government in business of an unanticipated scale. Instead of rallying the Dow plunged below 10,000, and then below 9,000.

By October and early November, it was clear that Democrats would sweep into office, and that they were ready for action.

Worst Week

The week that the incoming team seemed most ferocious was the week of Nov. 17. Two things happened then. The first was that the president-elect's new chief of staff, Rahm Emanuel, drove home his famous line, "you never want a serious crisis to go to waste." Meanwhile news reports said that the president-elect and Senator John McCain, the defeated Republican challenger, had agreed to work together, a signal that Obama might have no opposition.

The combination represented the potential for more change by government than many adults could remember. Not good. The day it took in the Emanuel statement — Nov. 19 — the Dow Jones Industrial Average dropped more than 400 points.

Over the spring, though, it became clear that the Republicans weren't going to support the Obama administration to the extent imagined in the fall. Even an all-Democratic Washington was confronting legislative limits. The market staged its rally.

Summer Rebound

This summer brought evidence that the president's signature legislation on health care might not come as fast as anticipated, or might exclude the radical part, the public-insurance option. By July, the White House found it lacked the votes to pass the most dramatic version of health-care reform.

Senate Majority Leader Harry Reid then announced that the lawmakers wouldn't be able to get a bill through before the August recess. The Dow jumped the 9,000 hurdle. Markets knew that lawmakers would be back at their desks come September, but they also believed now that Washington was capable of less than Emanuel had suggested.

The distinctions between different kinds of activity were first outlined by an economist at the University of Chicago, Frank H. Knight.

Knight drew a line between risk and uncertainty. Risk that can be quantified through theory or empirical work was one thing, he wrote: "insofar as the probability can be evaluated numerically by either method it can be eliminated and disregarded."

Different Risks

Risks that can't be measured are of a different type altogether. It is the unquantifiable uncertainty that interested Knight, who saw in it the possibility of profits for the bold few. But most of the rest of us just bury our heads in the sand.

Over time, theorists right, left and center have built on Knight's work or come up with their own versions.

Former Treasury Secretary Robert Rubin, who is now chairman of the institution where I work, the Council on Foreign Relations, has long emphasized the value of forcing problems into frameworks of probability. In other words, shoving as much risk as possible into the easier, quantifiable category.

Rubin's efforts and those of others in the Clinton administration reduced uncertainties and pleased markets: thus the 1990s rally. Former House Speaker Newt Gingrich's decision to shut the government rather than agree to administration spending plans produced a gridlock that likewise precluded Emanuelesque action.

Possible Explanations

You can argue that government activism stoked the recent rally and that the so-called cash for clunkers consumer spree generated the summer's rises.

Knightian Uncertainty, as it is known, is at least as plausible an explanation. Those trying to figure out how markets will move this fall might find cracking a copy of Frank Knight worthwhile.

I've written before about the Congressional Effect Fund, which buys and sells stocks on the premise that markets will rise when Congress is out of session — that is, truly inactive.

But you get the drift: big new legislation — bad. Government gridlock — good. Speeches to school children — outstanding.

(Amity Shlaes, author of "The Forgotten Man: A New History of the Great Depression" is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2009 Bloomberg

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