This post appeared yesterday on RealMoney; it has been updated. Click here for a free trial, and enjoy incisive commentary all day, every day.
The First Vote: What Went WrongI covered the vote in real time on RealMoney. Readers probably noted that, unlike TV experts, I never assumed that the bill would pass. The TV pundits followed a rule, usually reliable, that the leadership does not bring a measure to a vote until they have the votes. This time was a special challenge. Dare I say it was "different"? We were at the expected end of the legislative session, with everyone heading home for elections. There was no good way to delay the vote. In addition, the traditional whip structure was not really working. A whip is effective when able to get an accurate count, enforce party discipline and offer other inducements. These conditions were not in place. None of them. At the conclusion of the roll call, a shift of 10 votes would have been required for the bill to pass. I believed and stated that five GOP votes would have been matched by the Democrats. Later insider reports supported my guess. They just did not have the votes.
What's Different Now?There are several differences for today's vote. First, public opinion has shifted. It is not that the public embraces the bill -- many people do not. Many others, though, see more clearly the consequences of inaction. This is why radical policy change requires time and leadership. The polls show this shift. Second, there has been time to build a coalition. Let me try to illustrate with an example ripped from the yellowed pages of my old lecture notes. Suppose that you had a plan that imposed costs of $200 each on 90% of the population and conferred benefits of $150,000 each on 10%. The net societal expected value is (0.1 * 150,000) minus (0.9 * 200). There is a positive net societal benefit of almost $15,000 per person, but the benefits are highly concentrated. Building a coalition is a problem of compensating enough "losers" to make the measure attractive. This is a standard problem in political science, but it is something that the average hedge fund manager has never even thought about. I have given an extreme example to make the problem clear. What is happening? The measure is getting changed at the margins to induce new voters without losing those already on board. It is very difficult, since there are few inducements available. Cutting taxes attracts GOP conservatives, but offends Blue Dog Democrats. On the other hand, they only need to swing a few votes. Here is a nice article illustrating the tradeoff in coalition building via two specific legislators.
The ResultI am going to venture a few conclusions here. First, the whip system will work better. The leadership will have a better read on votes. They have provided inducements and cover to switch a few votes. Second, they will not bring it up this time until they are ready. Market observers will be cautious after being burned once. It will provide the chance for a trade. Third, the legislation will pass. The combination of changed factors is enough to get the needed votes.
Other FactorsComplicating all of this is the timing of the vote, occurring today after the jobs number is announced. I expect a very bearish jobs number (more on this in Columnist Conversation, as I usually do), so the market may be weak in front of the vote. It will actually provide extra pressure on the voters. My methods are not geared to short-term "rentals," so I defer to my fine colleagues on these subjects. On this particular occasion, I think there will be a chance to "get long" this morning. I also expect that financial stocks, homebuilders and regional banks will benefit from the legislation. I am long these ETFs -- iShares Regional Banks ( IAT) and iShares U.S. Home Construction ( ITB). My model-based trading agrees with my fundamental analysis. The system has been long these sectors while short the general market, a good combination so far. I may choose to lift my short hedges this morning.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider IAT and ITB to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.