By timestaff
July 26, 2011

When last Friday’s debt ceiling talks came to a frustrating end just hours after the market closed, it made sense to expect a repeat of what happened during the TARP debate. In 2008, the Dow plunged 777 points after the House voted against the Troubled Asset Relief Program. Congressional representatives turned around and later approved the bailout package.

But Monday came and went without the kind of market slump that could push lawmakers to a debt ceiling deal. When markets closed on Monday, the Dow Jones industrial average had dropped 88.36 points, or 0.7%. The S&P 500 fell 7.59 points, or 0.56%. Numbers for the year were up.

The bond market, too, didn’t see dramatic shifts. Yields for short-term Treasuries — which would be the most immediately affected in the event of a U.S. default — stayed calm. Yields for 10-year Treasuries ended the day just four basis points higher, at 3.00%.

With just eight days left before the Aug. 2 deadline, the debate in Washington is still roiling. But the market response has been subdued.

One possible reason for the markets’ unexpected stability: Fox Business News reported on Monday that White House officials have privately told major U.S. banks that a default won’t happen, even without a debt ceiling deal. But that still doesn’t eliminate the looming threat of a credit downgrade brought about by the impasse.

Perhaps the markets are calm because there’s no certain way to hedge against a U.S. default. After all, economists don’t know what exactly will happen if the U.S. fails to raise the debt ceiling — just that it won’t be pretty, either for the global economy or for the average consumer’s pocketbook.

Then there’s the nature of Wall Street. Recent reports of healthy second-quarter earnings suggest that there’s money to be made — as long as you’re a corporation or a forward-looking investor. People riding that wave may be keeping one eye on Congress, but many still remain confident that lawmakers will come to a deal, especially because of the severe consequences of failing to do so.

And that’s part of the paradox that has led to the markets’ surprisingly understated response. The scenario if the debt ceiling isn’t raised has been described as catastrophic — and investors are betting that lawmakers won’t let it come to that.

At least for now. As of Monday evening, it looks as if Wall Street has called Washington’s bluff. But unless the debt ceiling is raised, the markets may feel the full impact of the political debate after Aug. 2. And then we might actually see a TARP debate redux.

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