CRs versus BRs -- This Ain’t Your Father’s Shutdown

CRs versus BRs -- This Ain’t Your Father’s Shutdown

Printer-friendly version
a a
Type Size: Small

Portfolio managers, most of them not old enough to remember past U.S. government shutdowns, are analyzing past ones and yawning. Markets hardly moved at all when the government shutdown twice, in late 1995 and early 1996. But those were times when the U.S. was flush with money and politics were accommodative. Times are different now. As newly elected House Appropriations Committee Chairman Harold Rodgers said, “I ran to be head chef, but I wound up taking charge of the latrines” and added
“The depth of the problem, the depth of the hole we are in was not obvious, frankly until very recently.”  Rogers is 73 years-old and has been on the money-giving committee for 28 years. If he is surprised, it is easy to understand why portfolio managers will be surprised too.

How deep is the hole? Indiana Gov. Mitch Daniels and OMB director under George W. Bush, said on "Face the Nation" that U.S. fiscal problems, "threaten not just our prosperity, but the survival of our republic”.
A year ago, Moody’s, the global rating agency, warned “Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability … will require fiscal adjustments that, in some cases, will test social cohesion.” If Daniels and Moody’s are right, if we have a shutdown, it will not be like past ones. Our fiscal troubles are far deeper, and sides are more politically polarized than any time in 150 years.

As a nation we have two paths. Congress can continue to enact short-term Continuing Resolutions that trim at the edges and offer no vision for how the government spends tax dollars. The risk is we will
reach the point when there are no more easy cuts, political polarization erupts, the factions split, and we have a government shutdown or a series of them. The second path is Congress can get off the CR path and pass a long-term Budget Resolution and a Reconciliation Act that gets the U.S. firmly on the path to fiscal
sustainability. This path requires fiscal hawks to be willing to lose a battle to win the war – give up on short-term CRs and get on the BR path.

In a shutdown, will one side just give up? Probably not. They will fight, and once they begin, it will be hard to stop. China will continue to get interest payments, but payments to thousands of American businesses for goods and services will be stopped. Millions of families will be affected. Then markets will deliver a hammer blow.

I was a partner for fifteen years in one of the world’s most successful global hedge funds. Experience in the biggest market swings in the past 20 years tells me Congress needs to ask itself how markets will react this time if investors worldwide see U.S. gridlock. Will they begin to think in terms of  crisis-driven spending cuts and tax increases a la Greece and Ireland? If they do, portfolio managers will sell the stocks and bonds of companies that will be hurt most by the changes. Because most U.S. companies structured their operations to max profits under the old tax and spending rules, most U.S. companies will be hurt by crisis-driven fiscal adjustments. The resulting stock and bond selling will drive up company borrowing costs and weaken the
U.S. economy, driving down tax revenues and making matters worse. These are the kinds of risks to our republic and social cohesion that Governor Daniels and Moody’s see.

What might be in the Budget Resolution that could prevent all this? The Gang of Six, among others, is working on it. Republican Sens. Coburn, Chambliss, and Crapo, and Democratic Sens. Conrad, Durbin
and Warner are drafting legislation that builds on the Simpson-Bowles and Domenici-Rivlin commission recommendations. As Chambliss told Grover Norquist, the goal of the group “is to protect taxpayers, not
special interests. To do so we must analyze every aspect of the federal budget, including the tax code.” Appearing with Warner before a group of reporters recently talking about fiscal sustainability, Chambliss said." The way you do it is put everything on the table".

A BR would presumably look something like Simpson-Bowles – cutting Medicare, gradually raising the retirement age for Social Security, cutting defense and discretionary spending, and slowly reducing tax
expenditures like home mortgage interest deductions and corporate subsidies. These are all political third rails, but the Gang of Six understands that the long-term consequences of doing nothing are much worse than going out on a short-term political limb. The timing is tight. The most recent CR funds the government for another three weeks and contains nearly the last of the cuts Democrats and Republicans can
agree on. We can maybe pull a few more handfuls of easy cuts out of the bowl, but after that, agreement will be impossible. Without agreement, shutdowns are likely.

Mr. Dugger is a recently retired a partner in a global asset management company and is now managing partner of Hanover Investment Group, an investment consulting firm