WASHINGTON — As Congress lurches about in search of a deal to raise the nation's debt ceiling before an Aug. 2 deadline, ordinary investors are watching anxiously to see whether there'll be a repeat of Sept. 29, 2008.
That's when lawmakers in the House of Representatives defied the Federal Reserve chief's warnings, as the financial crisis was exploding, and rejected a Bush administration bank-bailout plan, objecting to such an expensive big-government intrusion into the private sector. That sent the Dow Jones stock index plunging 778 points in a single day.
As they were then, the retirement savings of ordinary Americans are at risk if Congress misses the debt-limit deadline. If it does, the government won't be able to fully cover its debts, which would cause the first default in U.S. history, risk panicking financial markets, send interest rates soaring and kick the economy into renewed recession.
Most analysts still bet on an eleventh-hour compromise, but the question is whether big institutional investors will wait patiently for a last-minute deal or move before then by demanding higher rates for purchasing U.S. debt. That could force the hand of lawmakers and erode billions, if not trillions, in retirement wealth in the process.
So what's an average Joe or Jane to do? Get out of stocks until the debt-ceiling showdown is resolved? Get into bonds? Put savings under the mattress?
Most investment advisers say to stay the course, with a caveat.
"Reaction to these kinds of market events is typically not a very productive approach. Many people who got out during the financial crisis didn't know quite when to get back in and missed the entire run-up" since April 2009, said Brian Reid, the chief economist for the Investment Company Institute, the trade association for large mutual funds and other investment funds.
"Whatever happens here is going to be over and done with, and people who would have bought or sold into that period of uncertainty would likely lock in losses and hurt themselves in their 401(k) plan."
As the ever-bullish chief investment strategist for Wells Capital Management in Minneapolis, Jim Paulsen advises investors to look past the debt-ceiling theatrics.
"The debt ceiling to me is way down the list. I don't think that's a big risk, and I think investors should largely ignore it. It's a self-imposed limit and it wasn't imposed by an outside law, regulatory body or rating agency or anything, and it's made to increase over time," he said. "It's been done in the past and it will be done again."
Paulsen is more optimistic than most that the U.S. economy will accelerate sharply in the second half of this year, lifting spirits along with retirement plans.
Yet there's still a huge potential risk. If lawmakers fail to reach a deal, things could get ugly fast. It happened on Sept. 29, 2008. The Dow lost more than 7 percent of its value on the day that House Republicans led the defeat of President George W. Bush's initial Troubled Asset Relief Program, now known as the bank bailout. Lawmakers reversed themselves four days later, but deep damage had been done.
"That was the catalyst for the Great Recession. We were losing 750,000 jobs a month just a few months later," said Mark Zandi, the chief economist for forecaster Moody's Analytics. "This was a catalyst for a complete washout in sentiment. Things were already falling apart when this happened. There was just nothing to break the free fall."
Today, the economy is not in recession, it's in a recovery, albeit a weak one. Corporate profits are soaring, and manufacturing and exports are growing. There's forward momentum.
However, that's being slowed by the protracted debate over raising the debt ceiling, with some lawmakers even suggesting that a short debt default would be OK. It has fostered growing uncertainty in financial markets. Yields on the bellwether 30-year Treasury bond have been rising, and the cost of buying default insurance against U.S. bonds has risen 20 percent since April. The political strife has hurt confidence, weighing on business and consumer sentiment.
"This goes to the war in Washington over the debt ceiling.... Each day that goes by, the financial markets grow more worried," Zandi said.