Saturday, December 8, 2012

Which Fiscal Cliff Are We Talking About?

Which Fiscal Clift Are We Taking About?

Which fiscal cliff will we go over first?

There was no fiscal cliff on November 5. There was no fiscal cliff on Election Day. There was no fiscal cliff during the election. 

President Obama is planning a 21 day vacation in Hawaii over January 1. What fiscal cliff?

Suddenly a fiscal cliff emerged on November 7, a veritable chasm. The Bush Tax cuts will expire as will the temporary reduction in payroll taxes. Sequestration will hammer the defense budget and certain domestic spending accounts.

Many predict a fiscal Armageddon.


America is actually facing four fiscal cliffs, any one of which may prove catastrophic to the economy.

The first is, of course, the widely publicized January 1 fiscal cliff, which dominates the news.

The second though is also on January 1. It is a certainty.

ObamaCare tax increases kick in, including a 3.8% surtax on investment income for homeowners earning $250,000 or more and single filers with income of $200,000. The new tax rates on capital gains will be 23.8% and 43.4% on dividends. Penalizing capital investments chills job creation.

Other tax increases include raising the Medicare withholding tax for employees to 2.35% and 3.8% for self-employed, and a 2.3% excise tax on medical devices.

Reducing take home pay is not a stimulus to the economy.

These taxes will impact the middle class and all workers, even those earning less than $250,000. Taxing medical care does not reduce the cost of medical care.

The tax increases on employees will result in a reduction in discretionary spending, which will depress the private economy.

A $2,500 cap is imposed on flexible savings accounts and a new threshold of 10%, up from 7.5% applies to itemized medical deductions.

The individual and employer mandate taxes take effect on January 1, 2014, as does a    tax on insurance companies. Once again, how do we lower or contain the cost of health insurance by taxing it?

The third fiscal cliff is the almost infinite contingent debt of the United States. These are not the formal debt, which exceeds $16 trillion, carried on the books of the United States, but the guarantees and implied obligations of the federal government.

Think of the hundreds of billions of dollars needed to bail out Fannie Mae, Freddie Mac, AIG, the banks, and savings and loans. $138 billion has been paid out to rescue Freddie and Fannie in so far.

We’re looking at possibly even more in the future for Freddie and Fannie, but now the Federal Housing Administration is in danger of needing a bailout. Warnings were posted about the FHA when Freddie and Fannie collapsed, but the FHA ignored them.

The FHA does not purchase mortgages, unlike Freddy and Fannie, but it insures them. It is charged by law with keeping a 2% reserve. It ended fiscal year 2012 with a negative 1.44% reserve.

FHA loans insured between fiscal 2007 and 2009 may reach $70 billion in claims. 25.82% of the 2007 loans are in arrears, 24.88% of the 2008 loans, and 12.18% of the 2009 loans. Perhaps 1/6 of all loans are delinquent.

FHA loans can be on properties with as little as a 3.5% down payment. It is forecasting losses of $46 billion. It recognizes that it may need a bailout next year.

Shaun Donovan, Secretary of HUD, has asked Congress to back off because FHA insurance is critical to the recovery of the housing market. We remember how that worked out with Fannie and Freddie.

Federally guaranteed student loans are another ticking time bomb. The government currently guarantees $956 billion in student loans, up $42 billion from June to September, and 56% since 2007. Over 11% are currently 90 days or more in arrears, up from 8.9% in June. These student loans require no collateral or underwriting standards.

Let us not forget the Post Office, the purveyor of snail mail. It had no debt in 2005, but reached the Congressionally imposed debt limit of $12 billion on September 28, 2012. The Post Office has lost over $20 billion since 2007. It defaulted earlier this year on a $5.5 billion payment to its retiree health benefit fund. The House and Senate are divided on what to do with the Post Office.

Flood insurance, available only through the federal government, loses a fortune every year.

Other contingency liabilities exist. Illinois’ Governor suggested we bail out state and municipal pension plans, which could be an additional $2 trillion.

The fourth fiscal cliff is the most insidious. Think of Greece, Spain, and even California. It is the national debt with the devil of compound interest. The national debt was $7.9 trillion in 2009. President Obama has more than doubled it in 4 years to $16.358 trillion. The debt is borrowed money, upon which interest must be paid.

The interest on the public debt in fiscal year 2012 was $360 billion, more than the budgets of NASA and the Departments of Education, Labor and Transportation combined.

At some point, probably in the near future, creditors will start requiring an interest rate higher than .01% on T Bills. At some point the Chinese and Japanese will cut back on buying our debt. At some point social security will start cashing in the notes it holds from the Treasury Department.

At some point compound interest will start eating up the federal budget quicker then the entitlements. Think of PacMan and Ms. PacMan.

We are headed over a fiscal cliff, maybe more than one.

The four fiscal cliffs have the potential to come together as a perfect fiscal storm.

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