What's a fiscal cliff and is the US about to fall off it?

US growth will drop next year if Congress and the President can't come to an agreement to steer away from the "fiscal cliff". Politics will decide if the US goes off the cliff or avoids it.

Last summer, Congress's delay in raising the US debt ceiling cost the country its AAA rating. The compromise that finally got the higher debt ceiling approved created the fiscal cliff that's now looming.

In a nutshell, the fiscal cliff (which could also be thought of as the triple witching hour) is what will happen to the economy when the tax cuts in the $747 billion stimulus package run out, some or all of the Bush tax cuts are allowed to expire, and the automatic cuts to federal expenditures beginning in 2013 Congress approved late last year take effect.

Estimates put the impact of the cliff at 5 points of GDP. Ouch...

Fixing LIBOR...

Barclays Bank is in the spotlight for submitting its LIBOR fixes to benefit its trading positions. It's not the only major bank to have engaged in the practice. Investigations should soon result in charges being filed against other "too big to fail" banks. Institutions that have said they are being investigated include Citi, JP Morgan Chase, Royal Bank of Scotland, UBS, and Credit Suisse.

The scandal underscores that trading has replaced lending as the lifeblood of banking. The nature of the bank-client relationship has changed. Clients have become counterparties, which translates into "buyer beware". Financial institutions don't have the same fiduciary responsibility to counterparties as they do to customers.

Who takes the losses that offset the traders' gains from manipulating LIBOR? Counterparties to the trades did. Some  can be considered sophisticated investors. Several hedge funds and some traders have filed suit on contracts traded through the Chicago Mercantile Exchange. Charles Schwab filed a complaint in 2010.

Others, like cities, relied on the advice of their bankers. Some US cities are suing to recover the losses that artificially low LIBOR rates would have caused. Here's an example of how it works. A city enters into an interest rate swaps based on LIBOR. The bank pays its municipal counterparty a variable payment based on LIBOR. The city pays the bank a fixed payment. If LIBOR is artificially low (because of rate fixing), the city receives a smaller payment. Nassau County's comptroller estimates that the county may have lost US$13 million (on swaps on outstanding bonds with a face value of $600 million) because of rate fixing.

The suits will be very difficult to win. But, banks that are suspected of fixing rates can expect to spend "tens of billions of dollars" on lawsuits, according to a professor at Stanford University.

More importantly, the trust indispensable to well-functioning markets will be further undermined.

Anything worth mentioning about the election results?

As anticipated, Mexicans returned the presidency to the PRI on July 1. Enrique Peña Nieto, the nominee of the PRI and the Green Party, sailed to victory over the PRD and PAN candidates: with 95% of votes counted, Peña won 38.1% to AMLO’s 31.7% and Vasquez Mota’s 25.4%.

What’s worth mentioning about the results? For one, Peña’s margin was much smaller than the daily polls published by El Universal newspaper in conjunction with the reputable survey firm GEA-ISA projected. The final poll before the elections gave Peña 46.9% of the vote, 9.2 percentage points more than he actually received. The 14-16 percentage point margin Peña enjoyed in the polls earlier in the campaign eroded to just 6.3 points on July 1. So, although Peña won comfortably, his victory wasn’t the landslide that had been anticipated.

Neither did the PRI win control of Congress. Although the PRI and its coalition partner, the Green Party will hold more seats than any other party or coalition on both chambers of Congress, they will not hold a majority in either house.

Including the seats won by its Green allies, the PRI-Green’s 232 seats fell well short of the 251 seats required for an absolute majority in the Chamber of Deputies. In fact, the coalition won fewer seats than the 239 the PRI alone held in the previous legislature. The two parties’ seat total fell by 30. The 2014 election could give Mr. Peña an absolute majority in the Chamber of Deputies but, for the next two years, he will have to look for the votes he needs to pass legislation from other parties. Even if Peña can bring along all ten of the Panal’s deputies, he will still have to get some of the votes he needs for a majority from the PAN or the PRD.

In the Senate, the PRI-Green alliance did better. They are expected to win 57 of the chamber’s 128 seats, 16 more than in the previous legislature. Unlike the US where a third of the Senate is elected every two years, in Mexico all senators’ terms run the same six years as the presidential sexenio. The July 1 voting means that unless the new president can persuade some senators to change parties, he will never have a majority in the Senate. And, the senators whose votes he needs will have to come from the PRD or PAN.

Voters left no doubt they are disillusioned with the PAN. Their presidential candidate, who garnered only a quarter of the vote, was almost as far behind the second place AMLO as AMLO was behind Peña. In the Chamber, the PAN also finished third, behind the PRD and its Worker Party (PT) and Citizens’ Movement (Movimiento Ciudano) allies.  The PAN is expected to end up with 118 seats, 24 less than in the prior legislature. The PAN is expected to be the second largest party in the Senate. Its expected 41 seats will be nine fewer than before.

Although AMLO lost by a much larger margin than his razor thin 2006 loss, the PRD and its allies picked up a hefty 52 more seats in the Chamber of Deputies. Their expected 140 seats will make the left the second largest grouping in the Chamber for the next two years. The party’s gains came at the expense of the PAN and PRI-Greens, which dropped 24 and 30 seats, respectively. The PRD-PT-Citizens’ Movement coalition lost four seats in the Senate. With just 29 seats, the left will be a distant third force in the Senate.