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The Fiscal Cliff: Does your Company Need a Parachute?

A letter dated October 18 carried an ominous warning for the U.S. president and Congress: fail to reach an agreement about how to side-step the fiscal cliff, and the already-fragile stability of global financial markets and the U.S. economy could crumble.

"The U.S. economy and the businesses and households that depend on it need your help," wrote members of the Financial Services Forum. "Even more important, the solvency, productive capacity, and stability of the United States, as well as its moral authority as a global leader, require that its fiscal challenges be credibly met. We trust that you will do everything you can to deliver the necessary leadership at this crucial time."

What could spur a managing partner and 15 CEOs of major banks and insurance companies - including the heads of Bank of America, Goldman Sachs and MetLife - to pen such a note? Would a failure to reach an agreement before the deadline on December 31, 2012, really send the country back into a recession? At an even more basic level, what is the fiscal cliff? The coverage of this pending issue is heating up as the presidential elections and the expiration date for tax expirations and spending cuts (totaling more than $606 billion) approaches. It may be time for businesses to hunker down and start making contingency plans. But first, some background information.

What is the fiscal cliff?
The fiscal cliff refers to a series of tax cuts created under President George W. Bush, as well as other tax provisions, that are set to expire at the end of the year. It also refers to the statutory debt ceiling, stimulus efforts set forth by President Barack Obama, and a series of spending cuts that would slash funding for defense programs, Medicare and other programs, The New York Times reports.

The national deficit swelled in 2009, when President Obama enacted a $787 billion economic stimulus plan, and partisan arguments over the debt continued in April 2011 (with a near-government shutdown) and in August 2011 and February 2012, when Democrats and Republicans squared off over deficit reduction plans and raising the debt ceiling, the Times explains. According to an International Monetary Fund estimate cited by MNI News, the result could be a fiscal withdrawal of more than 4 percent of gross domestic product in 2013, which could stymie growth next year.

Does November 2 have anything to do with it?
The fiscal cliff hasn't seen much air time on the debate trail, but the tangentially related tax cuts have. Both candidates have not explicitly addressed the approaching deadline. Reports surfaced that the Obama administration would be ready to veto efforts to stop tax increases and spending cuts if Republicans refused to tax hikes for wealthy citizens, The Washington Post reports. Meanwhile, Republican presidential hopeful Mitt Romney is reportedly working with his team to plan a fiscal cliff strategy, but has said publicly that he would support delaying the decision until after the inauguration, having separate bills instead of packaging a solution, according to The Associated Press. 

Will Congress push companies over?
The Wall Street Journal surveyed economists to gauge the possibility of the U.S. falling off the edge of the cliff, forecasting a mere 17 percent probability that the mandated tax hikes and slashed spending would push the U.S. back into a recession. Meanwhile, 22 percent of responding economists predicted Congress and the president would come to a "compromise that deals with the cliff and makes a dent in long-term deficits," and 60 percent anticipated the two groups would come to an agreement "that kicks the can down the road, but doesn't seriously address underlying deficit."

Some companies are preparing for the potential blowback by scaling back hiring, The Economist reports, citing a JP Morgan client survey that found 61 percent of its American clients were changing their hiring plans as a result of the fiscal cliff. Uncertainty regarding investments and tax rates does not ease the problem.

According to Seeking Alpha, investors would do well to prepare for the fiscal cliff. Although the source notes it's likely Congress will act to some degree to "cushion the fall," other experts predict a high chance of recession in 2013 or a gradual descent as the effects of the fiscal cliff manifest themselves. Companies dependent upon government contracts or the retail industry will be most affected, another Seeking Alpha article predicts. For any corporation, it may be best to batten down the hatches and minimize financial risks.

Comments

Topic Expert
Barrett Peterson
Title: Senior Manager, Actg Stnds & Analysis
Company: TTX
(Senior Manager, Actg Stnds & Analysis, TTX) |

The country needs to significantly reduce additions to debt, to approach zero additions. Debt reduction to zero on neither needed nor desirable. The fiscal cliff is serious if experienced with no modification, a sure prescription for a recession. Most individuals will see their after tax income drop by 3% to 5% of their gross income, a major hit. I am seriously considering chopping Christmas plans if not resolved this month...January will be a very late start.

Jeffrey McCandless
Title: Managing Partner
Company: Stone Harbour Partners
(Managing Partner, Stone Harbour Partners) |

There is a topical whitepaper titled "Sequestration-How To Prepare for the Potential Storm that provides some great insight on what businesses should do, not only in the face of Sequestration, but on an ongoing basis to mitigate risk and create increased value.

The elections will likely have an impact on ultimately what happens with respect to this whole area. I saw a matrix recently that described the different Federal Budget reduction scenarios based upon various successful party outcomes in the White House, Senate, and the House.

One thing is for sure, our country cannot keep borrowing money to spend. A common misnomer is that all Agencies will be subject to the same scalpel. Some Agencies will see their budgets actual increase year over year. There will be an emphasis on ditching failed projects and re-tolling spend towards newere, higher value projects.

No one's crystal ball is flawless, that is why the whitepaper I mentioned is useful, no matter which crystal ball one is looking through.

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