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Debt Default: How The Market Will React

Saturday, July 30, 2011


As lawmakers in Washington continue to bicker about what do with the nation’s debt ceiling, investment groups are fielding calls from clients hoping to understand what will happen to the stock market if Congress can’t reach an agreement this weekend.

On Friday, Moody’s confirmed the country will likely keep its top-notch credit rating, but didn’t rule out that the AAA credit could come with a negative outlook.

But local investment group heads and economic experts are divided as to what the nation’s failure to come to terms on a deal will mean for Wall Street when the market opens on Monday morning.

People Will Be Reluctant To Spend

Michael Costello, Managing Partner at Endurance Wealth Management in Providence, said people should understand that a U.S. default is not exactly like the average citizen defaulting on a loan. No one in Washington is going to lose their home over the issue, for example.

But Costello said the ripple effects of a failure to reach an agreement could send the market into crisis mode and that the economy could slowdown.

“They’re not really going to default,” he said. “But people may be reluctant to spend money.”

Costello said the debt ceiling could impact employment numbers and will likely result in a halt in major purchases.

“If you were thinking about hiring new employees, opening a new office or buying a new home or a new car, that’s just not going to happen.”

Nothing Like 2008

John Thompson, Managing Partner and Chief Investment Officer of J.W. Thompson Investments in Providence, has a more optimistic outlook. He said he has fielded calls from investors concerned about their 401k, but said he is cautioning them on making “all or none” moves.

“This is one of those events that come around periodically that cause investors pause,” Thompson said. “But if you go back in history and look at what was considered big time events, and you see how the market reacted, many times you see they did much better than people thought.”

Thompson said he has one message for his clients: “If you’re a long term investor, stay a long term investor and do not let the short term events worry you.”

Still, Thompson said there will be cause for concern if Congress can’t come to some kind of agreement. But he said the country is still in far better shape than it was during the 2008 recession.

“If we come to a total impasse, then I think we've got a problem,” he said. "But I think there's enough conciliatory talk that we will come to a deal. This is nothing compared to what we were looking at September of 2008. We don't have the edge of the cliff in sight right now.”

Confidence At A Low

But others say businesses and consumers will be hit hard by a U.S. default. Dr. Edward Mazze, Distinguished University Professor of Business Administration at the University of Rhode Island, said there will be a lot of uncertainty if a deal is not reached.

“I am disappointed that there is no agreement,” Dr. Mazze said. “From the perspective of the Rhode Islander, no matter what happens know, business and consumer confidence will be at an all-time low. Consumers will be hesitant to make major purchases because of the threat of higher interest rates and businesses will be reluctant to hire or make investments because of the uncertainty of higher taxes and interest rates.”

Dr. Mazze said Rhode Island could be especially hard hit by Congress not reaching an agreement.

“It will take even longer for Rhode Island to get out of this economic nightmare which has been going on for the last three years,” he said. “The demographics will cause seniors to be worried about their social security and other benefits, workers will be reluctant to retire since they will not know about their economic future and house values will continue to go down. All bad consequences because of a Congress that continues to ignore Main Street America.”

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