10/21/2010 05:00 pm ET Updated May 25, 2011

Get Ready for Gridlock

The prevailing view among pundits and bloggers is that the 112th Congress will have a bare Democratic majority in the Senate and a bare Republican majority in the House when it convenes next January. The phenomenon of a split Congress drives our overseas friends who live in parliamentary systems into cognitive dissonance, along with our domestic chattering classes.

But Americans take a split government in stride. Our Founders deliberately designed a system that does not care if one party has the majority, or if power is split between parties, or even if there are no parties at all. No parties is closer to what the Founders expected than the two-party system that developed a scant 8 years after the Constitution went into force. The business of governing, as the Founders saw it, should be give-and-take, compromise, and short term half-measures. Big changes can be made only if they have sustained support over an extended period of time.

In a split Congress, neither party will be able to significantly advance a strong agenda. What passes the Republican House will die in the Democratic Senate, and vice-versa. Uncontroversial, middle-of-the-road, and/or direly necessary measures will be the only ones that survive the legislative process. Also, they have to be measures acceptable to the president, because the evenly split legislature is very unlikely to be able to over-ride a veto.

Stock market followers like periods of Congressional gridlock. In the short and medium run, the market hates uncertainty. "No man's life, liberty, or property are safe while the legislature is in session," opined New York lawyer and politician Gideon J. Tucker. The quote is often erroneously attributed to Mark Twain. Twain, however, had famously low regard for the integrity and morals of the legislators of his day; he did say, "We have the best government money can buy."

Put into economic language, legislative gridlock means that investors can make calculations of risk that will not be upset, at least for a while, by changes in law. They can act on those calculations with more certainty.

And that means that investors will take more actions. If that pattern holds true, it could be a positive catalyst for the economy. The chattering classes still argue over the effect of tax policy on hiring. I think a far, far bigger factor is what will get the trillions of dollars of cash now sitting on the sidelines back into equity and debt markets. That is essential to get businesses and individuals back to buying stuff they think they will need in the near future. And that is what it will take to cause more than token growth in real economic activity, which is in turn what it will take to give businesses the confidence to hire, regardless of what tax consequences or incentives. In other words, Congressional gridlock could be good for the economy in the short run.

Of course, what works in the short run does not always work the same in the long run. In a Merrill Lynch study of market performance since World War II, the worst returns occurred when Republicans controlled both Congress and the White House. The best returns occurred when Democrats controlled both Congress and the White House. Returns were closer to average when power was split in Washington. While defying common political wisdom, this is historic economic fact.

The pundit and blog world also seems to agree that the 2012 election season will start on Wednesday, November 3, 2010. While I generally view such common wisdom with a boulder-sized grain of salt, I find this one compelling.

The mainstream media, and much of the blogosphere, seems inordinately focused on the open race for the Republican presidential nominee, who will have the difficult, but not impossible task of trying to unseat the incumbent. It's a more fun story for the media, because it plays out more in the open than not. There is no "obvious" nominee-in-waiting, and a juicy, public set-to between the party regulars, who are still chastened by losses in 2006 and 2008, and the insurgents, who despite being dubbed the Tea "Party" are not a unified group with a coherent platform or organizational structure.

But a potentially stronger drama is starting to play out on the Democratic side as the Obama administration and the party begin to plan for both the 112th Congress and the 2012 re-election drive. While less visible, this effort could prove more consequential that what is happening on the GOP side.

The looming gridlock in Congress may mean few large-scale legislative accomplishments, particularly compared to the massive legislative efforts put through the 111th Congress -- an accomplishment more impressive for overcoming the unwavering and vituperative resistance of Republicans. With even less prospect for bi-partisan cooperation in the 112th Congress than the 111th, Obama may find that executive branch-only action may be the only path open to advance anything more than token parts of his agenda.

We could see a substantial increase in recess appointments: Obama could fill out his team that way through the 2012 elections. And the team re-building is already in process: Emmanuel is gone, Summers is going, and Gates will soon finish his two-year "re-up" commitment. Recall that both FDR and Reagan massively revamped their cabinets and working teams after their first mid-term elections, bringing in the people who really created their respective legacies.

Another open question is how much attention Obama will give to rebuilding the Democratic Party apparatus along the lines of his very successful 2008 campaign. He could, like Bill Clinton, focus on getting himself re-elected and not on the party. But then he would, like Clinton, probably have little to show from his second term. Or he could, like FDR and Reagan, focus on the party, focus on building his team for the next six years, and set up further advances to his agenda, not just in his second term, but beyond.

The "beyond" is a key concept here. No president, even the most transformative, accomplished anything like his full agenda during his terms in office. It took until LBJ's Great Society in the late 1960s for the visions of the New Deal to be near-fully realized, 35 years later. It took until the second Bush presidency for the Conservative agenda started under Reagan to be mostly implemented, 28 years later. One could argue that we are still striving to fully realize Lincoln's vision of a truly free and truly united nation.

The mid-terms draw nigh. Cue the curtain for Obama Act II.