FINANCE: Government Debt and You

With the August government debt ceiling approaching, you may be concerned about what it means to you, your financial security and the probable outcome. While guessing exactly what politicians will do is impossible, it is widely believed that not extending the debt limit could result in a worse financial situation than we just went through. For this reason alone, we believe the following solutions and results are most probable.

Since 1917, the debt limit has been increased numerous times, usually associated with great political drama. If history repeats, the outcome will be a compromise. For the average investor, the probable result will be higher taxes for those in the upper-income ranges as well as higher taxes on dividends and capital gains. Budget cuts will most likely impact older Americans as Medicare and Social Security pose the greatest future financial challenges to the country if not addressed. And with the end of the Federal Reserve monetary easing programs (QE2), interest rates are naturally expected to rise.

The summary outcome appears to be a compromised “fix” at the expense of those who are older and those who are wealthier. If this is the case, you need to be prepared to have saved enough and that you are protected sufficiently against higher taxes and increased interest rates.

Without diving into particulars, the issues are straight forward, our government has been running huge deficits and we are maxed out on the national “credit card.” We have only a few options which span the spectrum of increasing our “limit” once again or making tremendous spending cuts mixed with increased taxation. Some combination seems to be the direction we are heading toward.

Regardless of the solution or political party posturing, the numbers indicate that the budget cannot be balanced strictly by cutting discretionary government spending. If we cut 100% of the non-defense discretionary spending, that would only account for half of the current deficit according to the government budget reports. Well, then how about cutting 100% of defense? That does not do it either. You would have to cut 100% of defense along with 100% of Social Security and then you cover the deficit.

From all the reports and numbers we have reviewed, it does not appear as though the budget can be balanced without spending cuts to Social Security, defense, Medicaid and Medicare while increasing taxes as well. This is our conclusion, what do others say on the matter?

Last December the Deficit Commission issued a report that was supported by 11 of 18 members with the following major points. Discretionary spending levels should be cut to pre-2008 levels with increases at 50% of inflation (thus not keeping up with price increases…a further “cut”). A recommended 15 cent gasoline tax for a few years. A cut to corporate and individual tax rates but taking back some mortgage deductions and tax benefits associated with municipal bond interest, dividends, capital gains and health insurance. While increasing Social Security age eligibility and making reforms to Medicare and Medicaid.

 The “Ryan Plan” focuses on spending controls to Medicare and Medicaid (mostly State driven to put them in control to promote hopeful efficiency). Then some kind of subsidized health care premium program along with some similar Deficit Commission recommendations for cuts to taxes but a reduction to some tax breaks. Social Security and defense spending seems to be largely untouched.

The President’s plan focuses on tax increases, lower interest costs and the majority of savings coming from non-defense discretionary, defense and medical programs. His proposal already assumes the repeal of the Bush era tax cuts already set to expire on their own in 2013.

So why not just cut some spending and increase taxes to fix this today? If the “fix” was immediate, the last recession would seem like a walk in the park as the economic hit would be too great. The reason why we believe the politicians will address this “appropriately.”

So what is the most likely scenario? Your guess is as good as anyone but we would expect a rise to the debt limit associated with some kind of budget limitation. This will kick the can down the road into 2012 where we have the same argument again. But from all the proposals and reviews from both sides of the aisle, the themes are clear. As a society we will have to save more for ourselves, rely less on government, pay more in taxes, especially those over $250k of earnings and expect less benefits coming from Social Security, Medicare and Medicaid. And every government program will be under fire, including defense which has to be cut as well.

When the family hits financial troubles, everyone feels it. From top to bottom, we all need to chip in on this one…and for a long time. Save more, protect your portfolio, globally diversify, position for higher taxes and stay tuned for changes and remain nimble

U.S. Treasury Debt Manager Miller Nominated for Finance Post

Mary Miller, the U.S. Treasury Department official responsible for managing public debt, is the Obama administration’s nominee for chief of domestic finance.

Miller, 55, would replace Jeffrey Goldstein, the Treasury’s undersecretary for domestic finance, who plans to leave the department at the end of this month. If she is confirmed by the Senate for the promotion, Miller would advise Treasury Secretary Timothy F. Geithner on policy issues concerning the U.S. banking and financial systems and regulation.

As assistant secretary for financial markets since February 2010, Miller manages the Treasury’s public debt and oversees the offices of federal finance, capital markets and government financial policy. Earlier today she reiterated the Treasury’s projection that U.S. authority to borrow under the $14.29 trillion debt limit would expire on Aug. 2.

Miller previously worked 26 years at T. Rowe Price Group Inc. in positions including director of the fixed-income division.

One of Goldstein’s responsibilities has been coordinating the Financial Stability Oversight Council, a group of regulators charged with preventing a financial crisis. The council is led by Geithner and includes Federal Reserve Chairman Ben S. Bernanke.

Sensex touches 19K on positive global cues; ONGC spikes up

The benchmark Sensex has touched an important psychological 19,000 mark today, for the first time since May 3, supported by firm global cues post lawmakers passed the crucial second austerity vote for Greece. There was a bit of volatility in the market.

ONGC shot up 5% to Rs 288 a share on likely royalty payment from Cairn.

CCEA has cleared Cairn-Vedanta deal with some conditions yesterday, wherein Cairn India will have to pay royalty to ONGC.

AK Hazarika, Chairman ONGC said benefit to ONGC would be minimum of Rs 18,000 crore. However, Carn India was down nearly 2%.

Vedanta group companies like Sterlite and Sesa Goa gained 1.5-2%.

DLF, HCL Tech, Reliance Power, Reliance Communications, Reliance Infrastructure, ACC, Ambuja Cements, Hindalco, GAIL and M&M were on buyers' radar.

However, Bharti Airtel tumbled another 2% after downgraded by Kotak.

Maruti Suzuki and HUL too were down.

At 9:19 hours IST, the 30-share BSE Sensex was trading at 18,927, up 81 points and the 50-share NSE Nifty rose 17 points to 5,664.

The CNX Midcap went up 48 points to 8,019. About 627 shares advanced as against 183 shares declined on National Stock Exchange.

Jubilant Foodworks plunged 5% on profit booking after trading at crazy valuations in last few days.

Timbor Home lost 8%, below issue price of Rs 63.

Videocon tumbled 6.54%. GTL fell 1% to below Rs 90.

However, Dish TV rose 2.5%. TVS Motor gained 2% on monthly numbers.

Mukand gained 9% after a block deal.

Orbit Corp, Hangung Toys, Redington, Exide, Hexaware and IVRCL were up 2.5%.

German Banks Near Agreement on Greek Plan

German financial companies pushed toward an agreement to roll over their Greek debt holdings as Deutsche Bank AG (DBK) Chief Executive Officer Josef Ackermann predicted banks would contribute to help avert a “meltdown.”
Representatives of German banks and insurers hammered out a draft proposal to present at a meeting today with Finance Minister Wolfgang Schaeuble and top industry executives, including Ackermann. The German firms, which are using a French proposal as a blueprint for discussions, are likely to commit to contributing to the Greek rescue, while calling for a Europe- wide solution, said people familiar with the plan.
Financial institutions would “offer our hand in a solution,” Ackermann told Chancellor Angela Merkel at a conference in Berlin yesterday. “Not because we’re doing it gladly, but actually to enable policymakers to do something so that we -- I’ll say it frankly -- so that we don’t have a meltdown.”
Commerzbank CEO Martin Blessing, speaking at the same event, said German financial institutions have reached a draft agreement on participation in a Greek rescue, although there are still “a few hitches.” The remarks by the CEOs of Germany’s two biggest banks coincided with the Greek parliament approving the first part of an austerity plan aimed at meeting European Union aid requirements and staving off default.

Debt Rollover

German and French lenders are the biggest foreign holders of Greek debt and their participation is key to the European Union goal of getting banks to roll over at least 30 billion euros ($43 billion) of bonds. German firms and the finance ministry are discussing the idea of rolling over bonds maturing until 2020, and not just those running through 2014, as had been first envisaged, said the people, who declined to be identified because the talks are confidential.
Talks yesterday centered on Greek holdings and how much debt firms are willing to roll over, the people said. Potential sticking points, including the maturity of the Greek bonds, whether investors would face writedowns on their current holdings, and how rating companies would view a rollover, were also discussed, they said.

Beyond Lehman

“If Greece goes into default, then we would have a disruption in Europe that could more quickly impact other countries in a way that goes far beyond what Lehman Brothers meant for us,” said Ackermann, 63.
The bankruptcy of Lehman Brothers Holdings Inc. in September 2008 set off a credit squeeze that forced governments from the U.S. to Germany to Britain to bail out financial institutions.
Ackermann, who is also chairman of the Institute of International Finance, which represents more than 400 financial companies, said they are “working around the clock” with special teams, rating companies and bodies overseeing credit- default swaps to test whether any agreement would trigger a credit event. He warned that any agreement is “highly complex” and could force investors to write down their Greek holdings by an estimated 30 percent to 45 percent if done incorrectly.
Lorenzo Bini Smaghi, a European Central Bank executive board member, called the French proposal to address the Greek debt crisis “interesting,” and said a credit event must be avoided. He spoke in a Les Echos interview.
Schaeuble will hold talks with the heads of German banks and insurers, his deputy, Joerg Asmussen, said June 28. The meetings are part of Europe-wide efforts to get creditors to share the cost of a second Greek bailout and prevent the euro- region’s first default, a year after a 110 billion-euro package failed to resolve the debt crisis.

French Plan

Schaeuble sees a French proposal to roll over Greek debt as a “good basis” for talks, Asmussen said.
Under the French plan, private investors would receive new Greek 30-year bonds worth 70 percent of their original holdings through June 2014, with the remaining 30 percent paid in cash on maturity. Greece would use 50 percent of the original amount to pay down its debt, with 20 percent invested in zero-coupon bonds through a special purpose vehicle that will be used as collateral to insure the banks get repaid.
Banks that roll over their debt under the French plan would receive 30-year bonds with a coupon of about 5.5 percent, which could be increased by as much as 2.5 percentage points based on the pace of Greek economic growth, the people said.
In a second option, investors would reinvest at least 90 percent of their redemptions into five-year Greek government debt with a coupon of 5.5 percent, according to the proposal.
Some German lenders may favor the first option, while others with shorter-term Greek debt may prefer the second.
The plan depends upon credit-rating firms not cutting their grade on Greece and existing or newly issued government securities to default, according to the French draft proposal.
The French plan to roll over Greek sovereign debt has the backing of most of France’s banks and insurers, and it’s now up to investors in Germany and elsewhere in Europe to agree to a strategy, according to two people familiar with the matter.