Falling off the fiscal cliff

Are we about to fall off the fiscal cliff? We’ve certainly heard a lot of chatter about it lately. I decided to check it out by talking with financial expert Reto Gallati, who has four possible scenarios that could play out in the coming months.

Gallati, formerly the chief risk officer and head of investments at Nuveen Investments, notes that “the pending expiration of the Bush Tax Cuts and the sequestration process represents a doomsday scenario which can only be averted through significant efforts by Congress to reach a compromise solution during the lame duck session of Congress before new leadership (or a new Obama tenure) takes place in January 2013.”

See also: 3 fiscal storms brewing

In our phone conversation, Gallati, who hails from Switzerland and is more attuned to a European attitude toward compromise, says that in the United States: “we stand at the foothill of the cliff, which in our case it is Capitol Hill. If we want to avoid what could be an extremely dire economic outcome, America needs our elected officials to demonstrate leadership. Without significant movement soon, our economy teeters at the edge of the precipice, poised to fall over the cliff if politicians in Washington fail to find a timely agreement.”

Gallati says that he sees one of four scenarios that could occur:

• Congress and the President could agree to punt the issue into 2013 by signing a temporary measure allowing the tax cuts to remain in effect for a temporary period. Tax increases would be averted and the spending cuts could be delayed until after the inauguration and a new Congress is elected in 2013.
   
• A modest compromise, where Congress and the President reach an agreement containing a combination of tax increases and spending cuts. In this instance, the core of the fiscal cliff will be avoided and the key issues of the budget cuts will be pushed further out.
   
• The lemming scenario — Congress and the White House fail to reach an agreement and America’s economic recovery goes over the cliff.
   
• A grand bargain is reached between Congress and the President, in which both political parties agree on a compromise that addresses fiscal issues, spending cuts and taxes.

“Avoiding the fiscal cliff will require a bipartisan compromise by both parties to allow the incoming president — whether it is Obama or Romney — to move forward,” says Gallati. “Once the uncertainty of this issue is removed, the market can refocus on fundamentals; uncertainty will diminish and billions of dollars sitting on the sidelines could eventually come back to the financial markets.”