The Debt Ceiling Has Been Reached Again

December 27, 2012

Treasury Secretary Geithner announced today that we would reach the debt ceiling on December 31. 2012.  However, he has some options -like postponing payments to pension plans- that will keep us from defaulting until as late as April.
 
President Obama would like the debt ceiling raised as part of the "Fiscal Cliff" agreement. Rather than come to congress every time the debt ceiling is reached, Mr. Obama would like Congress to give the President authority to raise the debt-ceiling limit whenever it was needed. The Republicans proposed this once in the past as well. I do not think this can pass the House at this time.
 
Incidentally, the debt ceiling came out of the debate to establish the Federal Reserve in 1913.  Congress was worried that the government would spend and the Federal Reserve would print too much money debasing the dollar and destroying purchasing power. So In order to get the votes needed to establish the Federal Reserve, Congress passed a bill limiting the amount of Sovereign debt that could be issued to $2 billion dollars.  We are now talking $18 trillion as a stopgap measure. 
 
In any event, the debt ceiling will probably be part of the Fiscal Cliff negotiations.  If you remember the last time we debated the debt ceiling, it took a 10% market correction before the politicians got serious.  Also, we might see S&P start talking about another credit rating downgrade if it seems that the political parties cannot get something done. It may be different this time, but keep your positions hedged if possible.   

The Great Disconnect

December 24, 2012

Several recent events indicate that financial companies may be, once again, coming into favor. But remember, caution and hedging are required in our noise driven, centrally planned world.     

1. A week ago, the Federal Reserve increased the amount of money they are creating from $40 billion a month to $85 billion a month. That's $1trillion more dollars going into the banking system over the next year. This will enable the banks to get rid of a lot of toxic assets and allow them to reclassify assets which will increase their excessive reserves (they have over $1.4 trillion now) and reduce reserve requirements (think bank profits).
2. At the same time, the Central Banks have a coordinated, multi-national Central Bank lending/currency program to help shore up sovereign debt.
3. Last week, Greek sovereign debt was upgraded and their credit rating moved up to stable (they did get part of the $16 billion they need to pay bankers). Result: Greek bond spreads narrowed and Europe equities rallied.
4. A few days ago, Meredith Whitney (a key bank analyst) put a buy on BAC and Citi. She stated that after the next stress tests, BAC should be able to buy back stock, raise its dividend and add billions in capital. One of her reasons is that they have worked off a lot of bad assets.
5. Also, the market thinks a deal will be made on the Fiscal Cliff in that taxes will be raised and spending cuts will be done with smoke and mirrors so there will not be any real cuts (i.e. $350 billion saved in reduced interest costs over the next 10 years, $180 billion saved from Chained CPI numbers for Social Security increases, etc.). Therefore, no immediate cuts and more spending (Sandy relief, a $3.5 trillion budget, $1 trillion in new money by the Fed, etc.) implying that we will not have a recession (negative GDP) in 2013.  

 Net: Thanks to Ben's money, the economy and the markets are on different trajectories. Or to put it another way, the status quo will be maintained at any cost until we meet the black swan.   

Five Thorny Issues In The Next Five Weeks

November 20, 2012

There are several very difficult, very divisive issues that need to be resolve over the next five weeks or four of them will be automatically implemented on January 1, 2013. We know we are going to get higher taxes in 2013 and we may get some spending cuts (but I wouldn't hold my breath for much more than extensions).

Resolved, postponed, or kicked down the road, they should impact (including volatility) the economy and the markets. Following is a summary of these issues so you can begin to prepare for them.

1. The Fiscal Cliff

This is the automatic spending cuts and tax increases that go into effect on January 1, 2013.

The spending cuts amount to 3% of discretionary spending and 3% of defense spending. Per current legislation, the cuts are automatic and politicians cannot pick and choose which items to cut and which items to leave in place. However, as you could guess, they can vote to change anything; and they will because each side is not interested in cutting spending, they are only interested in saving or protecting the spending that is important to them.

Tax increases are also supposed to be automatic. If they are:

Personal income tax rates will rise to 39.5% for the top rate

The Alternative Minimum Tax (ATM) becomes a factor at lower levels

The 2% payroll tax holiday goes away

Estate taxes go back to 55% and for much smaller estates

2. ObamaCare Taxes become effective January 1, 2013

           

            Dividend tax rates go from 15% to your personal income tax rate

            Capital gains tax goes from 15% to 20%

            Investment tax (an additional tax) of 3.8% on dividends

            Exemptions reduced on child care credit and the marriage penalty is back

            Expense limits decrease (what expenses and amounts)

            State and local sales tax deductions are reduced

            1040 deductions reduced (medical)

            Flexible Spending Accounts will be limited to $2,500

            New Medicare wage and salary tax (0.9% above 200,000)

            New Medicare Investment tax of 3.8% (wages above $200,000)

Note: if these remain unchanged, you may have to consult your accountant. This information is only intended to illustrate what might happen and may not apply to any one individual.

3. Debt Ceiling Limit (will be reached before end of year)

This is not a new spending authorization; the increase is for spending which has already been committed to. Last time (last August) this "battle" resulted in a market decline of about 10% and a reduction in the U.S. Credit Rating. The credit agencies have said this new increase without a reduction in spending could result in another credit downgrade which could be a risk to interest rates and bond values.

4. FOMC Meeting and the end of "Twist"

The Federal Open Market Committee (the Fed) meets for its regular meeting on December 12. One thing under consideration will be the "Twist" program which was designed to keep long-term interest rates low and thereby help the housing industry will expire on December 31. Will they renew it, expand it or drop it in favor of something else?

5. Transaction Account Guarantee (TAG) expires December 31, 1212

In the debt crisis, the government (FDIC) raised deposit insurance from $100,000 to $250,000 and made it unlimited for non-interest bearing transaction accounts. When this expires, the estimated $1.4 trillion in cash accounts of corporations and other depositors could leave the small/medium-sized financial firms and go to the large, too-bigger-to-fail firms because they have an implied guarantee.

Election Result: We Want To Maintain The Status Quo, But..

November 6, 2012

After spending $6 billion in platitudes and demagoguery -without addressing a single, important issue - the result of the election was simply to maintain the Status Quo: Democratic President and Senate and Republican House. But now, the President and Congress have to deal with the real issues: spending, revenues and debt.

Mandatory spending (mostly Social Security, Medicare, Medicaid) plus the interest on our debt amount to about $2.5 trillion per year. These are policy programs so the payments are not voted on by Congress, they are made automatically every month just like telling your bank to automatically pay these bills from you checking account each month.

This $2.5 trillion yearly total is paid from federal revenues (mostly taxes) which amount to about $2.5 trillion per year (about 18% of GDP.) Great, except there are 10,000 baby boomers being added to this payroll each month plus the costs of inflation.

But, we still have about $1.2 trillion per year of Discretionary Spending (for things like Defense, Education, Homeland Security, etc.) Since we are out of money, we borrow these funds so we really spend about $3.6 trillion per year, borrow $1.2 trillion and add it to the debt each year.

So, mathematically, how do we solve this problem?

In recent polls, 80% of people want the government to cut spending; 80% of people do not want cuts in mandatory spending; and 66% of people do not want tax increases. Go figure. But we must to do something before our credit card is maxed out.

So after blowing $6 billion on hopium and personal attacks, we are back to raising the debt ceiling and blaming the "other side" for all our problems: The Status Quo.