Monday, November 12, 2012

Fiscal Cliff HYPE coming to a theater near you

Yes, there is a real deadline coming that should force some compromise in Washington.  I'll give you my best guess of how it plays out but first let's separate hype from reality.

What is this cliff the talking heads are all talking about so breathlessly?  Well, the Budget Control act of 2011 instituted a combination of forced spending cuts and the forced expiration of temporary tax cuts which could cut up to $500 billion from our projected deficit in 2013.  That's the good news (I guess) that we'd only have about a $500 billion deficit left to deal with.  The bad news is that these moves (primarily the spending cuts) will likely lead to a contraction in our economy and in all likelihood a slide back into recession. 

The worst case scenario would be no compromise and a complete implementation of the BCA's  cuts.  However, I think this is an unlikely scenario.  The much more likely scenario is that we hit a fiscal "speed bump" and a compromise is reached to maintain the status quo.

Here's my 50,000 foot view of what I think will happen:

* taxes on dividends and capital gains are going up (this raises revenues but allows the Grover Norquist's of the world to say "See he/she didn't raise marginal tax rates) the only question is how high the rates will go.

* The payroll tax cut will probably be extended again.  This is an easy giveaway that is popular on both sides of the aisle.

* Special tax benefits - like accelerated depreciation for companies and the sacred mortgage interest deduction are in the cross hairs.  I never thought Congress would really touch the mortgage interest deduction but if you think about it where would the effect of this be the most pronounced?  Where property values are the highest and guess where property values are the highest?  Those blue coasts on both sides of the US (NY, NJ, MA, CT, CA, WA) and the impact on someone with a $85k home in Montana will be less pronounced.  I hate to see politics driving economic policy but it could play a role here.

* Military spending - this will probably be the most difficult negotiation and I don't know how it will end.  I suspect there will be some cuts in civilian staffing but I do not think we'll come close to cutting $100 billion from defense.  If I were President Obama I'd call up Gov. Romney and ask if he'd like to head up a special project.  The US defense department would be the perfect private equity target - valuable assets, workforce issues, an industry that technology could change - and Mr. Romney would be the perfect person to head a commission on streamlining the military.  I'm only half-joking on this idea.

So hopefully, at this point you can see that the fiscal cliff is likely to be a little more than a road bump.  It is unlike the debt ceiling debate which nearly crippled the economy in 2011 (unfortunately, we'll probably have another one of those debates in the next 3 months).

However, this won't stop the media from reporting on the fiscal cliff like it is the second coming of Superstorm Sandy.  Look at the google search index for the term fiscal cliff in the past 2 weeks.

Every time the market dips expect people to jump to the "It's the uncertainty caused by the fiscal cliff!!!" line.  However, the bigger factors are Asia's slowdown, Europe's slowdown and weakness of our export data.


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