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VOL. 128 | NO. 10 | Tuesday, January 15, 2013

Debt Drama

Memphis financial veterans sound off on debt ceiling

By Andy Meek

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One of the common refrains among money managers and economists in Memphis is that the nation’s political leaders spend too much time wrestling with crises and not enough actually solving problems.

President Barack Obama speaks about the debt limit in the East Room of the White House in Washington on Monday. The debt-ceiling debate has frustrated local money managers and economists.  

(Photo: AP Photo/Carolyn Kaster)

Case in point: in a few weeks, the federal government will have reached the limit of its authorized borrowing capacity, the so-called “debt ceiling.” In truth, that moment already has come, but the U.S. Treasury Department has some procedural room to maneuver to keep things going for a few more weeks.

Based on the spate of financial crises of late that’s turned Washington into a mishmash of ungovernable fiefdoms, lawmakers likely will wait until the 11th hour.

Republicans then will insist they’ll only give ground on the debt ceiling in exchange for significant spending cuts. Democrats will read that as code for an offer to raise the debt ceiling if popular entitlement programs are slashed. Which they will be loathe to agree to, arguing the debt ceiling vote is a formality at best – a step toward paying for things Congress already has approved.

Meanwhile, the first question to someone who has to follow events like these because of their effect on the financial services industry might rightfully be – what brand of aspirin do you prefer?

“Remember,” said Waddell & Associates president David Waddell, “it took Europe three years to make real progress, with interest rates punishing the periphery. The U.S. interest rate environment is far from punitive, making political progress ‘voluntary.’”

In other words, someone who’s obese but not currently facing an imminent health scare is not likely to voluntarily give up junk food. Likewise, markets have not signaled major concern over the U.S. fiscal picture, so Waddell’s point is that lawmakers don’t yet have any reason to voluntarily make politically unpalatable choices now.

“It’s hard to find many austerity volunteers in positions of consequence in Washington,” Waddell said.

John Phillips, chief investment officer of Red Door Wealth Management, said his firm sees two potential scenarios playing out in the debt ceiling debate.

The first option, which Red Door regards as the most likely outcome, is that the debt ceiling will be raised with few “real” spending cuts. Those cuts likely would be in the form of reduced future spending rather than cuts to current spending.

That would result in very little change to the trajectory of the debt and deficit problems over the long term, Phillips said.

“The good news is that the financial markets could respond favorably to such an outcome, as the fears of austerity are side-stepped and government spending continues to support economic growth,” Phillips said. “With the debt ceiling and fiscal cliff issues in the rearview mirror, removal of some uncertainty and $85 billion a month in liquidity from the Fed, markets could once again ‘melt-up’ in 2013.”

Meanwhile, the second option Red Door sees as likely involves a solid plan of spending reform that reduces actual levels of current spending, as well as dealing with welfare reform, which would help reduce the long-term budget deficit and set the stage for future economic growth.

“However, the main detractor with this solution is austerity,” Phillips said. “And such cuts will have an additional drag on economic growth in the short term.”

His point is not unlike what would happen if a borrower who owed a large credit card debt decided to pay it off by allocating every penny of his salary to pay off the outstanding balance. There would, of course, be positive effects. No more credit card debt. His credit score likely would improve, and his borrowing ability would improve as well.

But using every penny of salary to accomplish that goal would mean forgoing things – like eating. Washington, similarly, has to juggle a comparable concern. Cut too much, and what’s good for the deficit is bad for economic growth.

“When (too much in) spending cuts are combined with the recent tax hikes, it could push the economy into a recession,” Phillips said.

Robert Trimm, chief investment officer with Legacy Wealth Management, said the debt ceiling decision can be used as a tool for the country to focus back on what its spending priorities should be.

“I would argue that we are already past the debt-to-GDP point that implies that future economic growth will be slower than the historic average of a little over three percent,” Trimm said. “And simply put, we need higher economic growth if we want the ability to pay down our current obligations.”

But here, Waddell breaks with that assessment and said what likely will happen in a few weeks is the same thing that’s happened in many of the recent fiscal fights in Washington: much sound and fury, signifying nothing.

“My guess is that this becomes another patchwork quilt we all worry about that amounts to nothing,” Waddell said.

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