Dow Sinks Day After Election; Obama to Inherit Bad Economy

The new president will be left with an economy like no other in modern history.

November 3, 2008, 6:28 PM

Nov. 5, 2008 — -- The stock market took a major beating today after the election of Democrat Barack Obama and Democratic gains in both the House and Senate. The Dow Jones industrial average losing almost 500 points and markets in Europe also saw drops.

Initially, stocks fell as investors cashed in from a week-long rise in share prices. But then in the afternoon the sell-off gained speed as traders started to question exactly what an Obama presidency would mean for American businesses.

Investors also shifted their focus back to the economy in anticipation of Friday's job report where the government is expected to announce roughly 200,000 in lost jobs in October.

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With the closely watched presidential election over, the business world is now bracing itself for the new reality of a Democratic-controlled Washington. That likely means stronger oversight and regulation of the financial sector, a tax structure that is less friendly to companies, increased spending on entitlement programs and more labor-friendly policies.

The Dow started the day down about 100 points, fell 200 points by noon and ended the day down about 490 points or 5.3 percent. The Nasdaq lost 5.6 percent and the S&P 500 lost 5.3 percent.

In Europe, Great Britain's FTSE 100 fell 2.3 percent, the German DAX lost 2.1 percent and France's main index was down 2 percent. Asian markets were up 2 percent to 4 percent, following a strong rally on Wall Street Tuesday.

The Dow had ended Election Day up 305 points, or 3.3 percent. It was the best showing for the market on an Election Day ever. The previous record was a 1.2 percent gain in 1984 when Ronald Reagan beat Walter Mondale. Before 1980, the market was closed on Election Day.

Talk on Wall Street switched this morning from who would win the election to how will Obama shape his administration. Investors are closely watching who the president-elect will pick as his treasury secretary.

The likely candidates include former Treasury Secretary Lawrence Summers; Tim Geithner, the president of the New York Federal Reserve; and a distant third possible pick of former Federal Reserve System chairman Paul Volcker. New Jersey Gov. Jon Corzine's name has also been floated as a possible pick.

The former Goldman Sachs CEO said on CNBC this morning, "I'm never going to say never to anything. I like what I'm doing. I have not had any conversations with anybody about this job."

The Worse Crisis Since the Great Depression

Today's market woes just shows a little of what President-elect Barack Obama will face: the worst economic crisis the country has experienced since the Great Depression of the 1930s.

What began with the explosion of the housing bubble has unfolded into a far-reaching global financial crisis affecting everything from banks to retail sales to the auto industry. Consumer confidence is hovering at record lows and consumer spending has declined for the first time in 17 years as Americans prepare to ride out what economists think could be the most severe recession in decades.

The first order of business for the new president will be to stabilize the economic crisis.

Plan for Homeowners?

Helping distressed homeowners will be a priority for Obama when he enters the White House.

"Just over 1 million households will lose their homes this year in foreclosure," said Mark Zandi, chief economist of Moody's

With one in six U.S. homeowners now "underwater" on their homes -- owing their mortgage lender more than what their home is worth -- this wave of foreclosures is likely to continue, economists say.

Obama laid out a rescue plan for the housing crisis. Obama proposed a 90-day moratorium on home foreclosures, which would give some homeowners a chance to catch up on missed payments and give the government a chance to develop a systematic plan for rewriting the terms of unaffordable mortgages for qualified homeowners.

Obama also wants to empower bankruptcy judges to lower mortgage payments to keep people in their homes, something the mortgage industry opposes.

Help for the Jobless?

Rising unemployment is another challenge for President-elect Obama. As consumers slow their spending, businesses are being forced to lay off growing numbers of workers. Some economists expect the next jobs report, due out Friday, to show that as many as 200,000 Americans were cut from company payrolls in October.

Obama has pledged to extend unemployment benefits and eliminate taxes on those benefits. He supports allowing more leniency on hardship withdrawals from 401(k) and IRA savings accounts, by temporarily lowering or suspending the tax penalties on withdrawals.

Stimulus Round Two

Many economists believe to that to boost the sagging economy, Congress will pass another economic stimulus package, perhaps even before the new president takes the oath of office in January. That is particularly true if Obama wins.

"I think this will be one of the most busy lame-duck sessions of Congress ever seen if Obama wins," said Brian Westbury, chief economist with First Trust Advisors.

Unlike the $168 billion stimulus bill approved last spring that provided direct rebates to taxpayers to stimulate spending, this stimulus bill is expected to address a variety of policy actions.

Those could include extending unemployment benefits and food stamps, funding state and local infrastructure projects as a means to create jobs, providing federal funds to state governments to cover rising Medicaid costs, offering mortgage relief for struggling homeowners, implementing tax cuts or rebate checks or even extending existing tax rates, and possibly providing money to help Americans pay for higher heating bills this winter.

Who Will Be Good for Taxes?

Who will pay higher taxes and who will get a tax cut became a defining issue in this election, with "Joe the Plumber" becoming a symbol of American fears of "redistribution" of wealth through changes in tax policy.

Obama says he wants to preserve the Bush tax cuts for families earning less than $250,000 and wants to expand tax credits for low-income families as part of his Making Work Pay program.

For families making less than $250,000, Obama supports higher taxes. But he would eliminate income taxes on seniors making less than $50,000 and encourage job creation; he wants to eliminate capital gains tax on small businesses and startups.

Cars, Energy and More Jobs

The ailing auto industry will also be a challenge facing the new president. Thousands may face unemployment if General Motors, Ford or Chrysler is forced into bankruptcy. Obama says he supports some aid to carmakers, in addition to the $25 billion loan program approved by Congress in September.

Obama says he would create 2 million jobs by rebuilding the country's infrastructure and he hopes to create 5 million "green jobs" through investment in renewable energy and building out the broadband network to all corners of the country.

Market Reaction?

And how will the stock market react to Obama's election? Many have said an Obama victory is already "baked in the cake" on Wall Street. And while history shows that stocks tend to rally the day after a Republican victory and sell off on a Democratic victory, in the long term the outcome of presidential elections is not a reliable predictor of performance.

Like many American voters, traders on the floor of the New York Stock Exchange were ready for this long campaign to be over.

"I mean enough," said Jason Weisberg of Seaport Securities. "It seems like it's been going for the last four years."

Other Challenges

Kenneth S. Rogoff, an economics professor at Harvard University and a former economist at both the International Monetary Fund and the Federal Reserve, said earlier this week that the next U.S. president will grapple with a host of issues beyond the recession, such as a wave of retirements by the country's baby boomers that will put increased pressure on government services for seniors.

"Medicare and Social Security are just blowing up and calculations, which used to be long, dated problems, are starting to come to the fore," Rogoff said. The government's Social Security fund, in particular, will have no choice but to turn to deficit spending, he said.

The state of the environment, he said, will also have consequences for the economy in the coming four years. Rogoff said addressing environmental concerns may require new taxes or caps on pollution.

"To actually deal with it has profound economic implications -- that's why we avoided it," he said. "But we can't wait any longer."The president may also have to tackle the disparity in wealth among the country's economic classes, which, until recently, had reached levels not seen since the early 1900s, Rogoff said.

"Although the recent financial meltdown has gone a long way toward ameliorating those differentials," he said, "nevertheless that remains an issue."

The estate or inheritance tax, which generally applies to the very wealthy, is scheduled to be repealed in 2010. It may prove important to the president's work on income disparity, Rogoff said.

"Repealing the inheritance tax was highly questionable in terms of income distribution and the president needs to address issues like that," he said.

Social Security

Kent Smetters, a professor at the University of Pennsylvania's Wharton School and former deputy assistant secretary of economic policy at the U.S. Treasury, said that the largest economic issue facing the new president is the "looming entitlement programs."

Smetters said the problems with Social Security, Medicare and Medicaid are much larger in magnitude than the fallout from the subprime housing market and the government's bailout of Wall Street firms.

That bailout, he said, "is just an appetizer for the real deal to come."

He said the problems with these programs today are "much bigger" than what past presidents have faced.

"We've waited so long. You can't possibly increase taxes enough to deal with this problem," Smetters said. "We've actually exhausted all of our black powder at this point in terms of tax increases."

Next up, Smetters said, the president should work to cut the corporate tax rate.

"It's just not sustainable," he said. "We now have one of the highest statutory rates in the world."

India and China have a fast-growing middle class that now has money to invest. "It's going to be a lot less attractive for those countries to invest in the United States and for Americans to keep their money here," he said.

Keeping the tax rate at its current level would hinder investments and growth of our economy, Smetters said.

The third big economic area for the new president -- and Smetters emphasized that it was the third most important -- is the government bailout.

"In my opinion it is a far distant third," he said.

There is going to be a regulatory tangle administering the program and a call for a whole new set of oversight regulations for Wall Street.

But the key, says Smetters, is for the new president to determine what type of precedent the bailout sets for future businesses and investors.

"Does it allow for entrepreneurs and corporate executives to game the system?" he said.

A Global Economy

Lewis Alexander, chief economist at Citigroup Inc., said earlier this week that he sees a very significant set of economic challenges for the next president.

One key issue for the next president will be "getting the financial system back so that it is actually contributing to growth," he said

"In the last four weeks the situation has moved from what was a U.S. issue to a global issue, impacting emerging markets," Alexander said. Firstly, "the economy is contracting quite sharply, that would be challenge number one. The expectation is that the economy is going to be contracting through the middle of next year, with mild growth following that.

"The floor is just falling out from under, you saw that last week in the consumer confidence number," he said. "A lot of headway has been made with the [Troubled Asset Relief Plan] and other programs but that has yet to be played out."

Alexander commented before Tuesday's election that when Bill Clinton took office in 1992 and when Ronald Reagan took over in 1980 they faced a sort of cyclical challenge that is not the acute problem in the financial and global sector that is seen now.

"Inevitably whoever wins is going to have to focus on getting the economy going. That inevitably means they are going to have to rein in their priorities," Alexander said. "Both candidates have focused on health care and despite what has gone on economically, I think that focus will continue because unless you get your arms around that, it's going to be hard to make the long run work.

"If the economic situation weren't so bad you probably would have seen Obama ... come out with a big health-care push early on in the administration," he said. "It probably won't be that soon now but I think they will try to make a run at it."

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