Shut Down & Debt Ceiling Update

Of all the words we have heard thrown around describing the current situation in the U.S. Congress, buffoonery is the most appropriate. From every perspective, the circus playing out in Washington is absolutely ludicrous and more than a little scary. Opinions on why this happened and who is to blame are in no short supply, and depending on the author, will vary widely in both accuracy and relevance. As your trusted advisor, we want to assure you that we are monitoring the situation closely, and would like to give you our opinions on some of the more important aspects of this multi-faceted problem.

The Non-Shutdown Shutdown

We are currently in the middle of what can only (accurately) be called a partial shutdown of the US Government. Despite what the media and politicians want to call it, more vital government functions will remain open than will close. If you wanted to see the Statue of Liberty or a Smithsonian this week, you are out of luck. Fortunately, social security checks will still be issued, every aspect of Homeland Security will remain active, the FAA will still be monitoring the nation’s air traffic, the mail will continue to flow, Federal Prisons will remain guarded, and – ironically – the health insurance exchanges made available through Obamacare will remain online.

We believe the effect of the shutdown will be minimal in the short term, and do not believe it will have a meaningful long term impact on the markets. The possibility of short term volatility exists, however, we believe that a shutdown was already priced into the market. The longer the shutdown continues, the larger the risk; however we do not believe this shutdown will continue for too long. This is primarily because the more pressing concern, the potential for the United States to hit the debt ceiling on October 17th, will soon take center stage. Despite the fact that Congress is acting like a three year old throwing a temper tantrum, we doubt they have the stomach for both a shutdown and a default.

A breach of the debt ceiling, which is the legislative restriction on the amount of national debt the Treasury can issue, would be unprecedented. If the debt ceiling is not raised, then the US could default on its obligations. Such a default would send a shockwave through the global economy and almost certainly cause severe market volatility here and abroad.

Fortunately, we do not believe the US will actually default. There is little debate our country has a deficit problem. It needs to be resolved. Sadly, though, we have had to lower our expectations so far that solving the actual problem has taken a back seat to not running the country into the ground. Despite our fiscal troubles, the crisis before us is politically driven, and politically motivated problems are typically fixable, especially when polling suggests that voters do not support the action being taken by Congress.

The Politics

Typically we shy away from discussing politics or giving opinions on various political agendas. In this case, however, the problems at hand are all about politics. They are completely born of a dysfunctional political environment and the absence of leadership. Trying to form a conclusion about where this crisis will lead is next to impossible, but a little understanding of the underlying politics may provide some insights.

The continuing resolution to fund the government and the debt ceiling legislation have been blocked by a subset of the Republican party in the House that has refused to pass either without additional language that significantly weakens Obamacare.

While it is a well accepted fact that the healthcare law has some major faults and requires some changes, it is not related to, or even dependent on, either the continuing resolution or the debt ceiling. Using the shutdown and the threat of a default to gain leverage on the law has further deepened the political divide and further cemented the stalemate in Congress. For his part, the President has done little-to-no outreach to the Republican members in the House and, aside from several public lashings, has offered no compromise or willingness to negotiate. The President and the Speaker of the House have struggled to work together since the failure of the Grand Bargain last year.

Impassioned peaceful protest is the essence of any democracy, and legislative gridlock is certainly not a new phenomenon. What makes this situation unique is that sufficient bi-partisan support for these pieces of legislation already exists in the House. So why did we not see an 11th hour agreement to keep the government running like we did last year at this time and again with the fiscal cliff? The answer, we believe, is that both sides of this debate are keenly aware that the first party to blink in the argument over funding the government would be in a weaker position when it comes to the debt ceiling debate.

Given the short window before October 17th (not to mention the next election cycle), neither party could afford the political fallout from both issues, so they have combined them. Most seasoned lawmakers are now confirming that the two matters are essentially enjoined, and will likely be resolved together. While this may help avoid an even larger public spectacle over the debt ceiling debate, it is likely to spell bad news for the 800,000 Federal workers who are without compensation, because the shutdown will likely continue as the debt ceiling issue is sorted out.

Beyond this crisis, it is beginning to appear that any meaningful headway on a balanced budget, tax reform or any other critical fiscal function will need to wait until at least after the mid-term elections. It is now apparent that little cooperation will be possible within the current political environment. While some optimists suggest that the moderates from both parties may use this opportunity to broker a longer term grand bargain-esque deal, that prospect seems faint at this point. Absent any productive compromise, we anticipate the government to solve the immediate crisis and defer fixing the underlying issues – again. Further, we expect the cloud of uncertainty to remain a headwind to true economic recovery for the foreseeable future.

We will continue to monitor the situation in Washington, and remain vigilant for any impact it may have on your investments. Please contact us with any questions you may have.

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