Five Things Wall Street Wants From Congress

WASHINGTON ( TheStreet) -- Wall Street is watching the elections just as closely as any talking head on a nightly political television show -- with a few big items on its agenda.

Unlike the past few legislative cycles, though, Wall Street's biggest priority has nothing to do with bailouts or stimulus funds or batting down aggressive reform measures. Instead, the financial community seems to be hoping to get nothing accomplished at all.

"What the business community is essentially saying now is: 'Time out, here. Give us some time to internalize and digest exactly what's taking place and what it means,'" says Brent McGoldrick, who runs a research group within a division of FTI Consulting ( FTI).

Obama and his party may have taken control on a platform of "change," but Wall Street -- and voters -- seems to have had just about enough of it.

Republicans are expected to gain seats and probably take over the House of Representatives. The Senate appears less likely to see Republican dominance, while polls show a mixed bag of voter sentiment. A recent Rasmussen poll shows a wide majority of U.S. voters unhappy with the way things are going in the country. But another poll show Democrats still in favor, broadly speaking, and another poll shows that enthusiastic voters are swinging Republican -- as evidenced by recent Tea Party fervor and unexpected primary wins.

In regards to Wall Street alone, a recent poll performed by McGoldrick's group in Washington, D.C., found that 78% of business leaders would like Democrats to lose control of at least one house of Congress. But, according to McGoldrick, that's not a reflection of any ideological bent. Wall Street simply knows that a divided Congress is unlikely to get much done.

"You'd think they would want an overhaul and outright appeal of the last couple of years -- but that's not what they want either," says McGoldrick. "Overhauling and repealing everything from the last couple years just shakes up the snow globe again: 'Just when we started to internalize what this means, you go and repeal it' - swinging back and forth."

However, Wall Street isn't looking for outright stagnation, either. Jan Loeys, who heads global asset allocation at JPMorgan Chase ( JPM), says that while investors hope that a more business-friendly Congress will be ushered in on Tuesday evening, "reality may be more messy."

"The idea that gridlock in Congress is good for the economy is not obvious to us," Loey said in a report on Friday. "Gridlock surely promotes the status quo, but that is not great in a time when action is needed. But an election message that jobs and the economy are voter priorities should make markets more optimistic that growth friendly policies will be pursued in 2011."

Here are a few important items on Wall Street's legislative agenda, as candidates for the 112th Congress await election results.

1. TAXES Taxes are on the tip of everyone's tongue since the issue must be resolved, in part, by year-end when Bush-era policies expire. If that happens, wealthy Americans will see taxes soar. Tax rates on dividends, capital gains and inheritances will also rise dramatically. The so-called "death tax" has been a particularly hot-button issue among voters and deficit hawks. Wealthy celebrities who passed on in 2010 were even highlighted in USA Today as lucky for having croaked just in time.

"I expect one of the TV crime dramas to write an episode about an investor whose terminally ill parent is holding a large portfolio stocks and the accused assisted her parent to pass on before midnight New Years Eve," says Kevin Baker, a senior financial analyst at TheStreet's ratings division.

In several states, taxes have also been brought up on ballot measures: Repealing some business taxes and adding others in California; lowering overall sales tax and completely cutting taxes on booze in Massachusetts; cutting real-estate taxes in Missouri and Virginia; adding gaming taxes in Oregon; and changes to sales and income taxes in Washington.

But as far as tax legislation goes, it seems likely that Congress will punt any meaningful decisions for at least another year.

Mike Zolandz, a partner at law firm SNR Denton in Washington, says taxes is probably the only issue that the current Congress will have to face on its way out the door. He doesn't expect much to change between now and January, even if the issue remains "high on the radar screen"

"It's both a lame duck question and a 2011 question," says Zolandz. "We expect that they'll probably extend the Bush tax cuts by a year - maybe two, but more likely by a year. Then 2011 will become a planning year for broader tax-policy debates that will occur in 2012."

Jerry Kremer, a 23-year veteran of the New York State Assembly, thinks the status quo will last even longer.

"Having been a legislator myself, I know that when they have any doubt and they don't know what to do, they extend it as opposed to making revisions," says Kremer, who's now chairman of political consulting firm Empire Government Strategies. "It's probably going to be a two-year extension of the cuts, possibly with some minor changes. And they're just going to kick it off for two years 'til the 2012 elections."

Despite tough rhetoric early in the election season, it seems they may be right. Democrats pledged early on to only extend cuts for middle-class voters. Republicans dug in their heels, with some vowing to block any measure that didn't extend tax cuts to all.

But as the campaigns have progressed and anti-tax-and-spend coalitions have gained support among the electorate, Democrats have softened their positions. A recent report in the Wall Street Journal indicates that several liberal contenders have moved to the right to resolve the taxes vs. deficit debate. Russ Feingold (D., Wis.) has partnered with "Tea Party hero" Tom Coburn (R., Okla.) regarding deficit repairs, while Democratic candidates Chris Coons and Joe Manchin and Vice Presiden Joe Biden have signaled a willingness to work with Republicans on extending the cuts.

The Congressional Budget Office inadvertently threw a bone to Democrats in a recent report. The CBO projects that keeping taxes at the current level for another two years won't hurt recovery efforts in a significant way.

But, looking out on the legislative horizon, low taxes can't last forever -- there will need to be more tax income to offset enormous government spending. Congress will have to outline a clear policy on individual income taxes, business taxes and items like "carried interest" that have allowed hedge funds and private equity firms to pay lower rates than they otherwise would have.

"Higher taxes is a clear and present danger," asserts Erik Davidson, who works with wealthy clients at Wells Fargo Private Bank. "Particularly for the clients that we manage money for in the private bank, because they are the rich. They are the ones that -- and this isn't a political statement -- they will be carrying ... an even greater share of the tax burden going forward. It's simple mathematics."

2. ENERGY

Energy-and-climate reform was near the top of Democrats' list of things to get done last legislative session.

Then came the health-care brawl. Then came financial reform. Then BP's ( BP) Macondo well exploded. And, well...they decided to call it a day.

"We're gonna have to continue to make some progress on things like energy, which didn't get done," President Obama said during a recent appearance on The Daily Show .

But if Congress becomes as divided as some predict, there's little chance that any kind of sweeping legislation will be accomplished. Legislators punted on the issue this session because it was too difficult to get through -- even with a Democratic majority.

Industry groups -- particularly those representing the "smokestack" sector -- balked at potential costs of "cap and trade," which would have forced companies to pay for the pollution they spew. The auto industry doesn't like the idea of improving gas-guzzling standards on a government-imposed timeline. Oil companies are wary of what might come of any legislation related to offshore drilling, since the process of finding oil thousands of miles below sea level is already extremely costly.

"There will not be a big energy bill in 2011 or 2012," says Zolandz. "Not in this Congress."

However, it's possible that smaller legislative items could move through individually -- as long as they're marketed as consumer-friendly, rather than tree-hugger-friendly. Zolandz says individual packages on energy-efficiency, renewable tax credits or expanding exploration and drilling could attract bipartisan support.

"But a big, climate-focused energy policy piece of legislation is on the sidelines," he predicts. "It can be broken up into smaller parts but it's not gonna move on its own."

If Congress is too hamstrung to move forward the president's agenda, the Obama administration may accomplish its goals via regulatory agencies. For instance, the Environmental Protection Agency recently caused some waves by saying it will begin regulating greenhouse-gas emissions as pollutants.

McGoldrick, too, expects some progress on energy reform over the next two years. On Wall Street, he says, "there will be keen eyes to pay attention to what takes place."

3. (ACTUAL) ECONOMIC STIMULUS

Congress outlined $787 billion in tax benefits, direct spending, loans and entitlements in February 2009. In July, it also extended unemployment benefits for four more months, at a cost of $34 billion. Lawmakers also offered another $42 billion in aid for small-business last month.

All of that is separate from the $700 billion bailout package to save the financial system and mortgage market in 2008 and the $1 trillion the Federal Reserve injected into the economy last year.

Still, the economy sputters along: Unemployment hovers near 10%, lending continues to contract and housing is in the doldrums. Wall Street will be keeping a close eye on what proposals lawmakers come up with after the election to help move things along.

"The economy, the impacts on the market - those are the hot button issues," says Kremer. "These are the issues that Wall Street lives or dies by."

If economic conditions remain bleak, the Fed could move ahead with another round of cash injections into the economy, referred to as quantitative easing, or "QE-2." But voters are jittery about all the deficit spending - particularly when it doesn't seem to have done much good in any tangible way. As a result, it doesn't seem likely that Congress will pass any more giant stimulus packages. That's especially true if conservatives and Tea Party candidates gain more than a few seats on Tuesday.

Still, it's important for lawmakers to send out a different message than they've been accustomed to blasting out in recent years. The anti-bailout, anti-Wall Street rhetoric may work in wooing some voters, but it won't help move things along on the ground.

"We're going through a period where officeholders need a scapegoat and this year's scapegoat was Wall Street," Kremer says. "I don't think that's going to continue for very long. It's going to work in some races this year but I think they're finding it's counterproductive. In the long run, just like New York State needs Wall Street, so does the rest of the nation."

Wall Street doesn't seem to mind that the stimulus spigot has run dry -- or that Republicans appear poised to take control of at least one house of Congress. According to the FTI poll, a majority of the business community thinks business and economic conditions will improve with a divided legislature: 63% expect economic conditions to get better; 60% expect a bump in hiring; and 56% expect to invest more via capital spending.

But McGoldrick says Wall Street is still cautious due to the lack of clarity on certain policy items and recent turbulence in the economy.

"There is some optimism - although it is soft optimism," says McGoldrick. "I wouldn't call it runaway optimism by any means."

4. HOUSING REFORM

One might have thought Congress would address the central cause of the financial crisis in the sweeping financial reform bill it passed last summer. But the housing industry is still in such a precarious state that lawmakers, in conjunction with the Obama administration's policymakers, decided that tackling the great mortgage debate was best left 'til 2011.

Treasury Secretary Timothy Geithner has promised to outline a comprehensive plan for the future of mortgage finance in January, as members of the 112th Congress take their seats. It's sure to be a tough battle, since Fannie Mae ( FNMA.OB) and Freddie Mac ( FMCC.OB) -- the two government-financed firms at the crux of the issue -- tend to evoke highly emotional, and partisan responses.

"The first six months of the next congressional session is probably going to be one of the nastier periods of time in the government's history," Kremer predicts.

The current model of housing finance represents a classic "heads we win, tails you lose" situation for some players in the financial industry - thanks largely to Fannie and Freddie. Investors in traditional, conforming mortgage-backed securities were able to profit on the upside, as the housing market inflated. As the system began to unravel, the "implicit" guarantees the two firms provide proved to be quite explicit - with Fannie and Freddie requiring hundreds of billions of dollars in taxpayer assistance to stay afloat.

The White House, Congress and federal regulators have all acknowledged that the system needs fixing. Liberals would prefer the government retain a significant role in funding the housing market, particularly for disadvantaged Americans. Conservatives would like the government to exit housing-finance completely, winding down Fannie and Freddie gradually as the market adapts to the change.

Geithner held the first big conference on the topic of housing-finance reform in August; the Fed and FDIC co-sponsored another event this week. It's likely that lawmakers will hammer out some kind of middle-of-the-road agreement: New-fangled Fannie-Freddie replacements that offer explicit guarantees on mortgage debt and better protection for taxpayers. But the devil will be in the details, as they say.

McGoldrick suggests Wall Street is nearly pleading with Congress to be more specific about its policy goals, whatever they might be.

"The business community's message is, "Look, if you're going to pursue an activist agenda - which, by the way, we're not all that crazy about - you have to communicate clearly not only what you're going to do but help walk through what these changes are actually going to mean for our business,'" he says, "as opposed to enacting something, walking away from it and letting the chips fall where they may."

5. REVISIONS

Just when you thought health care and financial reform were over, Wall Street lobbyists are coming back for a second round. Regulators and corporations will be seeking so-called "corrections" to both legislative coups in 2011, as they sort out the best way to implement the details of broad reform measures.

>>>Read More: Banks See Midterms as FinReg Opportunity

"Technical corrections are in the art of the possible next year," says Zolandz. "With health care, I think there are some adjustments that need to be made that agencies - particularly the Internal Revenue Service - are finding don't quite work the way they thought they'd planned them to."

Some items have already cost the banking industry a pretty penny: Bank of America ( BAC), Wells Fargo ( WFC) and JPMorgan Chase have outlined hundreds of billions of dollars' worth of lost revenue, while Goldman Sachs ( GS) decided to dismantle its lucrative prop-trading operation. Meanwhile, Bank of America is in the process of taking a $23 billion write-down on its card business due to one particularly restrictive measure on interchange fees and TCF Financial ( TCB) is suing the Fed over the issue.

As far as health care goes, all of corporate America seems to be scrambling to figure out how to moderate costs and avoid some of the most restrictive components. Some companies, like McDonalds ( MCD), sought and received waivers on covering all employees.

But, overall, executives' comments appear to evoke a "wait and see" approach with many aspects of the financial reform and health-care bills. That's partly because they're not sure how, exactly, regulators plan to enforce broad rules that will take years to go fully into effect - or what they'll be able to win in the new legislative session.

Regulators and banks will need legislative clarity on some items before proceeding - and not all regulators see things the same way. The FDIC, for instance, is seen as particularly harsh on banks, as are individual examiners at the Office of the Comptroller of the Currency. Meanwhile, the Fed and broader Treasury Department are seen as more accommodative.

Zolandz predicts that, even more so than with Congress, "the next two years are going to be a series of running gun battles with regulators."

-- Written by Lauren Tara LaCapra in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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