The last time the Republicans in the House stuck in their heels and voted against legislation proposed by the President, the Dow fell 777 points. The President was George W. Bush and he was asking the House to approve TARP. A few days later, the House – Democrats and Republicans alike – blinked and approved the legislation.
This time the President is a Democrat and he is demanding that the Congress approve an increase in the debt limit. The stakes are high and if the debt limit is not raised we might see another collapse in the Dow. Who will blink first?
One answer is that we must ask who will get blamed by voters if the deal does not get made. In 2008, a Republican President was at odds with Republicans in the House. The further the Dow fell, the more the Republicans looked as if they were to blame. In 2011, each side can hope to pass the buck and blame the other if the debt limit is not raised. The side the voters blame will suffer in the next election. So both sides will dig in and other things remaining equal the war of attrition is worse.
Another answer is that the correct audience the politicians are playing to is not the voters but Wall Street. The collapse of AIG caught everyone by surprise but the risks of not increasing the debt limit have been discussed for months. Wall Street will suffer if the Government cannot pay owners of Treasury bonds. They and their lobbyists have the politicians’ attention. The campaign donations will dry up if the politicians play havoc with debt repayment. In this scenario, the war of attrition will peter out as each side chickens out in the face of declining donations.