Wall St crisis will call shots for next president

NEW YORK (Reuters) - Neither Barack Obama nor John McCain is known for economic expertise but it's a safe bet that managing the fallout from the financial industry's meltdown will be a top priority for the next U.S. president.

While both presidential candidates have been quick to promise reform, including broader power for regulators, investors warn that few of their policy proposals will survive perfectly intact after the November 4 election and the start of the new, post-Bush era in January.
"What they say and what they do will be very different," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Connecticut. "The events unfolding on Wall Street are impacting the real economy very quickly and will dictate what kind of economic policies are pursued."
Obama, a Democratic senator from Illinois, plans to raise capital gains and corporate taxes to pay for income tax cuts for Americans making less than $250,000 a year, but money managers said those may have to be delayed or pared back.
"It's just not a good idea to raise taxes when the economy is weak," said Chris Orndorff, who helps invest $50 billion at Payden & Rygel in Los Angeles. "It would be different if we were growing at 3 percent a year but, at around 1 percent, that would be a punch to the gut that we don't need right now."
On the other hand, with federal books already deeply in the red, markets will probably have to get used to some form of tax increase in the future, even though both Obama and McCain are proposing tax cuts -- albeit with different distributional effects.
The U.S. Congressional Budget Office is projecting a record budget deficit of $482 billion in fiscal year 2009.
And that was before the government took over $5.4 trillion of liabilities from home finance companies Fannie Mae and Freddie Mac and extended an $85 billion emergency lifeline to insurer American International Group.
Here, McCain may have to rethink $600 billion in proposed tax cuts that the nonpartisan Tax Policy Center says would swell the national debt by $5 trillion over the next decade.
Even former Federal Reserve Chairman Alan Greenspan said recently the country cannot afford tax cuts of the size and scope that the Republican senator from Arizona is proposing.
Leonard Burman, director of the Brookings Institution and Urban Institute's joint Tax Policy Center, put a finer point on it: "McCain says he'll offset enormous tax cuts with cuts in spending, but he would have to cut the size of government back to what it was in the 1950s to make the books balance."
SEEKING FLEXIBILITY
That the challenges are legion was made crystal clear this week, which began with the biggest stock market slide since the aftermath of the September 11 attacks in 2001.
Investors saw the demise of Lehman Brothers, a Wall Street institution, and the takeover of Merrill Lynch, both victims of an ongoing credit crisis that is at the root of the worst financial turmoil since the Great Depression.
This week's $85 billion bailout of American International Group wiped out common shareholders of the company but failed to calm financial markets, which are fretting about which financial firm will be the next to need serious help.
Meanwhile, steadily falling home prices and mounting job losses have bruised the U.S. economy badly, with some economists saying it is already in a recession.
"The next president will face a challenge the moment he walks into the White House," said Quincy Krosby, chief investment strategist at The Hartford.
"Markets need someone who is pragmatic and flexible, who can work both sides of the aisle and work with business. Wall Street does not want an ideologue in the White House, either on the left or the right."
Questions about how a new administration will navigate the rapidly changing financial and economic landscape abound. Given the turmoil of the credit crisis, the trend is clearly toward a more activist government, and both Obama and McCain are expected to support widening market regulation.
Then there is the question of what will happen to Fannie and Freddie, which own or guarantee about half of the $11 trillion in outstanding home mortgages in the United States.
Analysts say a Democrat might be more inclined to keep the companies as strong, national entities, while a Republican may lean toward breaking them up and selling them off.
So far, Krosby said, neither Obama nor McCain "has really articulated a clear-cut policy" on these issues or on strengthening the broader economy.
DIVIDED GOVERNMENT
Bob Doll, global chief investment officer at BlackRock Inc, with $1.4 trillion under management, said Wall Street prefers divided government because it keeps both parties in check.
"Without question, we know we will retain a Democratic Congress, so if history is any guide, the market would prefer a Republican president," he said.
But this year, it may not be as clear cut. Obama has raised some $8 million from the securities and investment industry, well more than McCain has.
"The Republican ticket has two people on it who seem to operate on gut and instinct as opposed to deliberation," said Gilmore, who added that he worries about McCain's admission earlier this year that his economic literacy is weak. "That's a scary prospect for financial markets."
All the uncertainty makes it tough to form investment strategies, said Tobias Levkovich, Citigroup's chief U.S. equity strategist.
Based on current policies, he said a McCain win would probably boost consumer discretionary stocks and energy shares, which would gain on McCain's support for offshore drilling.
Obama would be better for alternative energy companies and could boost the appeal of municipal bonds, since their yields rise on an after-tax basis when taxes go up.
"But I always tell investors to be wary of trying to invest on election themes," he said. "Fundamentals, valuations and earnings expectations are far, far more important."