Will the U.S. Default?

August 2 is debt limit d-day for the financial markets; and, from all outward appearances, the markets seem to be ignoring it. After being down several weeks in a row, stocks have snapped back sharply. Investors are focused more on some signs of economic recovery and expect a good earnings season.

DIY Investor attributes the seeming lack of interest on the part of markets to the assumption that Congress will overcome its typical stupidity and pass the debt ceiling. But pushing to the edge can be dangerous. Once the ground gives way, there can be a scramble to regain footing.

DIY Investor also assumes passage, but in the back of his mind there is that low whisper of "what if."

Sadly, it isn't clear if anything was learned from the 2008/early 2009 debacle. Do politicians realize how close the economic system came to going over the edge as they bickered over the stimulus package?  Do politicians remember the fears before the announcement that money fund balances would be guaranteed? Do any of them wonder what would have happened if money fund withdrawals had reached  a tipping point?

As with the 2008 housing crisis, there is no one that most people can point to as the "cause" (in my mind, though, there is no question - it was caused by Greenspan); and this is a big part of the problem.  All of the big spenders rant and rave about Congress being out of control, and it makes great sound bites; but, in the end, they'll point to others when the economic impact is felt.

DIY Investor will make a personal commitment to vote across the board against incumbents if this goes to the last minute before passage. Politicians need to grow up, put their personal vote garnering actions aside, and pass the debt limit. Next they need to get about the business of cutting spending and raising revenues and putting the finances of the country on solid ground.

Anything less and they need to be replaced - wholesale, IMHO.

Looming Debt Crisis - Should I Raise Cash?

The U.S. has reached its debt limit of $14.3 trillion, and now Treasury Secretary Geithner is magically pulling funds from obscure places to keep the country from defaulting on its debt. In the meantime, the players in the sandbox are grabbing their toys and not sharing, especially when there are cameras or reporters lurking in the vicinity. Political pundits are having a field day.

Investment markets view the ongoing stupidity with a jaundiced eye. Been there, done that. It always gets resolved. Check out this chart:

Source: Bruce Bartlett, Invictus

If it doesn't get resolved, bonds default, markets crash, and we have a revote - sort of like we did for the stimulus package. At least that seems to be the thinking of our political leaders. Then we can go back to worrying whether we will have an NFL season. News flash to NFL owners and political leaders:  sometimes it takes a long time for fans to come back.

But seriously, folks, people are starting to get scared. They're asking me if they should raise cash in their portfolios.

My position on this is clear. If it helps you sleep better at night, by all means raise cash. Know though that you should have an asset allocation that reflects your  risk tolerance. For this reason alone, I would advise against raising the cash position by more than 10%  above the planned allocation.

The asset allocation plan is based on the understanding that we'll experience volatile markets from time to time and need to be positioned to ride out the downturns. Riding out the downturns keeps us in the market for when it turns higher, which typically is when the news is bleakest.

Most investors should not worry about near-term developments. Market timing nearly always backfires. Witness those who got out in 2008 and 2009 and never got back in. What most investors are interested in is where markets are 10 to 15 years down the road. Even for retirees, a decent portion of portfolios is longer-term in nature.

For those who do raise cash, there is the problem of when do you get back in? With the debt limit debate, there is much that is going on behind closed doors and over lunch at the Capital Grille . Deals are being struck. Imagine waking up to the headline that the debt limit has been increased and that our political leaders have decided to exhibit some maturity and cut costs as well as raise some taxes. Seems far fetched, but politicians have reached agreements in the past that haven't been self-serving re-election motivated and, instead, have been in the interests of the American people. It's hard to think of any right off the bat, but I know there have been some.

So, bottom line IMHO:  raise up to an additional 10% in cash, if it calms your nerves in these chaotic times, but understand that market timing can be a tricky endeavor.

Disclosure:  This information is for educational purposes. Individuals should consider their specific situation, do their own research, and consult a professional before making investment decisions.

Future Crises Not Likely to be as Bad as 2008

Treasury Secretary Geithner on Wednesday told Politico that, although there will be crises in the future, they won't be as bad as 2008.

On the one hand, this is good news. It implies that a 50% drop in stocks, like we saw in 2008 and early 2009,  is not likely.

On the other hand, it raises questions about the naivety of the Treasury Secretary. Does he not grasp the enormity of the Federal budget situation and the dysfunctionality of the U.S. political system. Has he ever asked himself what will happen if interest rates spike higher? Does he grasp the implications of a world where the leading economic power is communist and it is stealthily buying up natural resources around the globe? Does he not fully grasp that crises come in different forms?

His reasoning is that the regulators have the necessary authority from the Dodd–Frank Wall Street Reform and Consumer Protection Act to step in to nip a crisis in the bud.

But this isn't the way things generally work. Setting up a system to solve the last crisis doesn't prevent the next one. In the 1930s, FDIC was established to alleviate bank runs. Guess what? In 2008 we had potential bank runs in a different guise - runs on money market funds.

Treasury Secretary Geithner's demeanor and overall guidance on the debt limit situation could, in fact, set off the next crisis. His "oh well, we've reached the limit but I have tricks I can pull to keep the government running" is just forestalling the necessary increase.  It is giving unwarranted comfort to people that we have time to solve the problem.

Instead, he should be out front with names of people who will be fully responsible for setting up a flight from Treasuries if  it reaches that point. He should emphasize that the American people do not deserve to have the global financial system tested because of outsized political egos. He should be emphasizing that an interest rate spike is possible if we come to close to the point of default.

 In 2006, Greenspan and Bernanke said the housing market weakness was not a serious macroeconomic problem. Today Treasury Secretary Geithner says future crises will be less bad.

I hope he's right!