Fiscal Cliff: Not Bailing Out, But Buckling Up

Even now, I'm not sure how much value I can add to the reams of commentary about the results of recent election and the coming "fiscal cliff," but it's hard to ignore the elephants and the donkeys in the room. So, for better or worse, I'll give it a quick stab.

• The election settled nothing. After 600 or 700 years of campaigning (a slight exaggeration) and $6 billion in political expenditures (shockingly true), President Obama remains in office, the Democrats retain a majority of seats in the Senate, and the Republicans control the House of Representatives.
   
• My hopes for a compromise--even on a short-term extension--are dimming. A quick resolution would quite clearly be the best outcome for the economy, and even a temporary extension would be better than nothing, but our political parties may see little upside for themselves in either. In fact, I suspect both Republicans and Democrats view their own leverage as increasing, day by day, as the fiscal clock ticks away.
   
• The fiscal cliff--horrifying as it is on its own--is but one of three massive legislative problems staring the country in the face. The continuing resolution funding government operations expires March 27, at which point we could be looking at a shutdown--but before we get that far into 2013, the Treasury Department has warned that the debt ceiling could be hit again before the end of this year, albeit with the possibility of "extraordinary measures" that could stave off default a little while longer. (Remember how smoothly and cooperatively the last debt-ceiling increase was handled?)
   
• As far as I can tell, there is actually plenty of room for compromise--except on the most critical point. Both sides have spending that they want to protect. There's a lot of talk about raising revenues by broadening the tax base. Neither the president nor the Republicans in Congress claim they want to raise taxes on the bottom 98% of households. But the matter of tax rates for the top 2% of households has all the hallmarks of a binary outcome. One side will win, the other must give in--and both sides claim the election provided a mandate for their position. (I'd like to be proven wrong here with, say, an agreement to extend current tax rates in exchange for a cap on tax deductions for high earners. In fact, this idea was floated by the Romney campaign.) The best compromise is one where both sides can come out and claim victory. But top marginal tax rates--not the total revenue raised--are now totem poles for each side, making it awfully hard to imagine a meeting in the middle being regarded as anything other than a win for one side and a loss for the other.

If I had to guess--and this is just purely my own personal guess--I'd now have to conclude that there will not be a compromise in place by Dec. 31. The political environment is so toxic, and the long-run stakes for both parties so incredibly high, that the two sides in this fight might not come together until after the bell has rung. Only then, with economic damage under way, will the broader interest groups outside of Washington scream for anything but the cliff itself. In a sense, we're going to have to have one more election, with various interest-group lobbies ranging from defense contractors to teachers unions descending on the capital for one last shootout. A $6 billion election couldn't settle the issue; perhaps only existential threats to the parties themselves--delivered in person by their key backers--will do the job.

So, Josh, what's the investment conclusion here? Here, I'm a bit of a longer-term optimist. Despite the fear it strikes in any well-informed person, the fiscal cliff may not represent a vertical plunge; it might be more like a roll down a steep hill. (By contrast, the threat of a debt ceiling-induced default of the federal government was much more of a vertical, binary, do-or-die event.) Assuming the country forces a compromise on our own newly elected or re-elected leaders shortly after Jan. 1, the damage on the economy could prove temporary. Without advocating for one angle or the other, I don't think that moderate tax increases coupled with moderate spending cuts will result in another recession, especially if these efforts are coupled with greater long-term certainty on fiscal policy.

In any event, I don't plan to sell any (let alone all) of our stocks in fear of what could happen during the next two months. I'm in this strategy with many years, even decades, of increasing dividend payments in sight, and I can't accomplish that goal if I dart in and out based on variations in the weather.

But while I plan to stay fully invested, I do want to have my seat belt firmly fastened--by which I mean to be mentally and emotionally prepared for a rocky ride until these issues are settled. Volatility is already heading up, with stock prices hanging on every fresh statement from President Obama and House Speaker John Boehner (R-Ohio). As the clock ticks down, stock prices will probably fall if last-minute hopes for compromise slip away. After a deal is done, the healing can begin, and I've even started to suspect there's a good deal of pent-up demand for both consumption and investment (particularly in the housing sector, a key spark plug for the nation's economic engine). Being prepared for exaggerated volatility means I shouldn't have to make hasty moves--which can all too easily mutate into mistakes--in the heat of the battle.

One more message, this time for Washington: Please, folks, didn't you learn how to cooperate in kindergarten? Just get it done, and then you can go back to your usual pointless posturing. Take away these recurring crises of the political class, and in all likelihood we in the rest of the country will find a way to do just fine on our own.