Stocks plummeted Wednesday as the re-election of President Obama reinforced fears on Wall Street that a battle over higher taxes at the end of the year will drive the U.S. economy over the so-called “fiscal cliff.”
The Dow Jones Industrial Average ended a day of tumultuous trading down 313 points at 12,933. The Dow and other major stock indexes lost more than 2.5 percent of their value.
The sharp drop reflected investor calculations that it was more likely that the economy early next year will suffer from the sudden imposition of $500 billion of tax increases and spending cuts — at least temporarily — as the White House and the Republican-controlled House wrangle over how to control the budget deficit and the future of George W. Bush-era tax breaks. Economists have warned that the shock could precipitate a recession.
Upon his re-election Tuesday night, Mr. Obama said he had a mandate to raise taxes on the wealthiest Americans, but House Speaker John A. Boehner has continued to insist that Republicans have a mandate of their own to prevent all of the Bush tax cuts from expiring at the end of the year, including those for the rich.
“We could sky-dive off the cliff,” said Matt Tucker, analyst with iShares. “While there is a possible income-tax deal in early January, prepare for politicians to wrangle” for weeks over the details as well as a measure needed to raise the national debt ceiling again early next year, he said.
The scenario is a recipe for turmoil in the financial markets, he said. “It would cause anxiety throughout the end of the year and into 2013, and the Federal Reserve might be required to step in to continue supporting the economy and markets,” Mr. Tucker said.
“The political landscape has changed little after the elections,” with both Mr. Obama and Congress stuck in the gridlock mode, said Nigel Gault, economist at IHS Global Insight. Democrats held their Senate majority in Tuesday’s voting, while Mr. Boehner and the House GOP held on to the strong majority they won two years ago.
While the election swept away any doubts that Mr. Obama’s health care law will be fully implemented next year and that he will keep Federal Reserve Chairman Ben S. Bernanke or someone like him at the helm of the central bank, it also appeared to freeze in place the current impasse between the White House and Republicans on spending cuts and taxes.
“Crucial uncertainties over fiscal policy remain just as severe as before” and are weighing on the markets, Mr. Gault said. “Divided government, as before, could be a recipe for complete gridlock,” although the incentive for “short-term obstructionism” by Republicans in hopes of winning the next election has been removed, for now, he said.
“If the president insists that income taxes on higher-income Americans must increase next year, and House Republicans insist that they must not, we risk complete deadlock and may at least briefly go off the fiscal cliff at the end of the year,” he said.
“This would be a recipe for turmoil in the financial markets and would threaten such a severe shock to the economy that the pressure to come to some sort of compromise would be extreme,” he said.