DC Crisis Averted

I don’t usually like to call the result of a game before it’s over.  But in this case I’m confident saying that the deal reached in the Senate today, which does nothing other than re-open the government through 1/15/14 and extend the debt limit to around 2/7/14, is a done deal.  The Senate is expected to vote around 6pm tonight (80+ will vote yes) and the House will vote a few hours later (I’d guess at least 65% will vote yes).  The President will likely sign the bill tonight, reopening the government by morning.

The crisis that never really was a crisis has been averted, miraculously (HA!), one day from the reported deadline.  Fear-mongering, yet again, served no purpose other than ratings and scaring people into making terrible financial decisions.  As I’ve been saying all along, there was a 0% chance of default or any permanent damage to the economy that would result from it.  Minor, temporary damage has been done though shaking the confidence of businesses and consumers, but we’ll recover from that.  However, nothing has been done to pass a budget and make the country’s long-term fiscal situation sustainable.  Over the next 3 months, which will include time off for holidays, Congress has to make some progress, or we’ll be right back in the same situation again with another “crisis” to start 2014.  We’ll see what they come up with.

For now, back to business as usual with the hopes that the last few days don’t become the new business as usual.

***Update, 11pm eastern time***

Senate passed bill 81-19 (I predicted 80+).  House passed bill 285-144 (66.4% vs. my 65%+ prediction).  Obama to sign momentarily.  Government will be open in the morning.  Debt limit extended to 2/7.  25 hours to spare from their 10/17 deadline.  Congress is getting better at this!

Quick Update On Debt Ceiling

For those not following via Twitter, here’s what I posted today:

4pm: The storm before the calm is building in DC. Gotta take the country to the brink so they can be heroes in bringing it back.

4pm: I’d say we’re two plans away from having a plan to pass a bill that sets guidelines for developing a plan before the next deadline #cankick

7pm: Another failed plan in the House. I think we’re one away from real deal now (with little substance but will avert the “crisis”)

Still confident a deal will come right before it has to (and that’s not 10/17 as is being reported), and the US will not default on its debts.  As I’ve been saying, the result would be so catastrophic, that no one in Congress will let it go that far and the President / Treasury will use all possible measures to make sure it doesn’t happen.  Fitch ratings agency put the US on credit watch negative meaning there’s risk that they would downgrade the US Debt in the future.  Immediately after, the orchestrated response was released by Treasury explaining how Fitch’s actions demonstrate the gravity of the situation.  Everyone knows this will get resolved, but the fear-mongering will continue in the press for the next few days.

What happens beyond the agreement is a potential issue.  Further short-term agreements, followed by a “crisis”, a shutdown, a threat of default, and then a kicking of the can again in another short-term agreement, will cause a broad loss of confidence in the US government and financial system.  If we keep managing “crisis” to “crisis”, we will eventually be faced with a CRISIS.  We’re not there yet, but it’s not that far off if this continues.

If you’re not following via Twitter, I encourage you to do so as I’ll post short bursts of relevant news or a quick thought here and there.  @TomAtPWA.

US Debt Default

More political posturing today as President Obama and House Speaker John Boehner both had press conferences to say pretty much exactly what they’ve said for the past two weeks. They’re saying it louder and more sternly each time, giving it full grandstanding effect. Obama won’t negotiate unless Republicans pass a Continuing Resolution and raise the Debt Ceiling, which is like asking them to leave all their chips outside of the poker game. Boehner won’t allow a clean Continuing Resolution or Debt Ceiling bill to be voted on in the House, even though they would almost certainly pass, without some negotiation on spending reductions or Obamacare concessions attached to it. In other words, they have a complete standoff.

I expect more of the same for another week or so, but I don’t think the sands running out of the hourglass come with a proportional increase in the chance of a US debt default. Since there is virtually no chance that a resolution will be reached until the last minute (likely a few minutes after the last minute), the probability of non-resolution should not increase as time passes. Financial markets don’t believe there will be a debt default. Countries, companies, and individuals continue to lend money to the United States at absurdly low rates (essentially 0% for a year, 1.4% for 5 years, 2.6% for 10 years, and 3.7% for 30-years!!). The chart below shows credit default swaps (CDS) on five-year treasuries in basis points. CDS pay out in full in the event of a default. 41 basis points means that people are paying 41 cents for protection on $100 of treasuries implying a four tenths of one percent (e.g. negligible) chance of default over the next five years. While slightly elevated from a few weeks ago, 41 basis points is actually about the average over the last four years, and still substantially lower than the 65 basis points during the 2011 debt ceiling “crisis”. Today, even after the grandstanding, those same CDS actually traded down to 37 basis points.

I’m not worried about a default, just like financial markets aren’t worried about it. I’m not worried about 11:59pm on October 17th either, because that is not the exact moment that a debt default would happen if the Debt Ceiling isn’t raised (ironically, the govt. shutdown has slowed spending for the last week, so there should be a bit more wiggle room). I’m confident the debt ceiling will be raised just before it needs to be raised. I really only worry about self-fulfilling feedback loops that occur in a negative direction (like the death spiral that occurs when businesses layoff workers in mass which results in less spending in aggregate in the economy which results in lower profits which results in more layoffs). I don’t worry about those things that provide a self-regulating effect. In this case, any increase in the probability of default would lead to an increase in the probability of politicians being held directly responsible for another deep recession, which leads to the sudden ability to be rational, compromise, and save their future jobs.

The stock market will continue to be jittery as program trading, momentum trading, and day trading dominate day-to-day volume and direction of movement. I have full faith that there will be no default and no permanent damage to the economy. When that becomes certain, the economy in aggregate, the actions of the Federal Reserve, and the profitability of individual companies will once again dominate the way the market is valued. I’m not making any changes to client portfolios or asset allocation models in general as result of the debt ceiling / continuing resolution “crisis”. As the old proverb states, this too shall pass.