Government Shutdown

The Committee for a Responsible Federal Budget (CRFB) has a full-disclosure discussion of what a “government shutdown” means and how it happens. There is also some important history in their working paper. Here’s the link: https://www.crfb.org/papers/government-shutdowns-qa-everything-you-should-know.

 
Note that the CRFB is a bipartisan organization. One need only look at the array of retired and former federal legislators on their supporter list to see that the organization attempts to avoid the present-day disruptive political culture war politics. Personal disclosure: I contribute to this organization. 
 
Here’s an excerpt. I encourage readers to review the entire document and use the Q&A function. 
 
What services are affected in a shutdown and how?

Each federal agency develops its own shutdown plan, following guidance released in previous shutdowns and coordinated by the Office of Management and Budget (OMB). The plan identifies which government activities may not continue until appropriations are restored, requiring furloughs and the halting of many agency activities. Essential services – many of which are related to public safety – continue to operate, with payments covering any obligations incurred only when appropriations are enacted. In prior shutdowns, border protection, in-hospital medical care, air traffic control, law enforcement, and power grid maintenance have been among the services classified as essential, while some legislative and judicial staff have also been largely protected. Mandatory spending not subject to annual appropriations, such as for Social Security, Medicare, and Medicaid, also continues. Other examples of activities that continue are those funded by permanent user fees that are not subject to appropriations, such as immigration services funded by visa fees. Certain programs that are funded through advance appropriations, such as those within the Veterans Health Administration, have been minimally affected during recent shutdowns.

Although many programs are exempt, the public is still likely to feel the impact of a shutdown in several ways. For example, in a full shutdown: 

• Social Security and Medicare: Checks are sent out, but benefit verification as well as card issuance would cease. While unlikely to happen again, during the 1995-1996 shutdown, more than 10,000 Medicare applicants were temporarily turned away every day of the shutdown.
• Environmental and Food Inspection: During the 2013 shutdown, the Environmental Protection Agency (EPA) halted site inspections for 1,200 different sites that included hazardous waste, drinking water, and chemical facilities, and the Food and Drug Administration (FDA) delayed almost 900 inspections. During the 2018-2019 shutdown, the FDA restored some food inspections a few weeks into the funding lapse for products that were considered high-risk.
• National Parks: In 2013, the National Park Service (NPS) turned away millions of visitors to more than 400 parks, national monuments, and other sites. NPS estimated that the shutdown led to more than $500 million in lost visitor spending nationwide. Many parks remained open during the 2018-2019 shutdown, though no visitor services were provided, and damage and trash build-up were reported at many sites.
• Air Travel: During the 2018-2019 shutdown, air travel was strained as a result of air traffic controllers and Transportation Security Administration (TSA) agents working without pay. Travelers faced longer lines as some TSA agents did not report to work and security checkpoints were closed, while the absence of ten air traffic controllers temporarily stopped travel at LaGuardia Airport and caused delays at several major airports.
• Health and Human Services: The National Institutes of Health (NIH) would be prevented from admitting new patients or processing grant applications. In 2013, states were forced to front the money for formula grant programs such as Temporary Assistance for Needy Families (TANF, sometimes described as “cash welfare”).
• Internal Revenue Service (IRS): As a result of funds provided in the Inflation Reduction Act, normal IRS operations would continue and all 83,000 employees would be exempt from furlough. In 2013, a backlog of 1.2 million income and Social Security number verification requests delayed mortgage and other loan approvals, and billions of dollars of tax refunds were also delayed. At least 26,000 furloughed IRS employees were recalled to work during the 2018-2019 shutdown in preparation for tax season, but 14,000 did not show up to work without pay.
• Supplemental Nutrition Assistance Program (SNAP): Though funding for the SNAP program is mandatory, the ability to send out “food stamp” benefits could be affected by a shutdown, since continuing resolutions have generally only authorized the Agriculture Department (USDA) to send out benefits for 30 days after a shutdown begins. During the 2018-2019 shutdown, the USDA paid February SNAP benefits early on January 20, just before the 30-day window ended, but it would have been unable to pay March benefits had the shutdown continued. In addition, during any shutdown, stores are not able to renew their Electronic Benefit Transfer (EBT) card licenses, so those whose licenses expire would not be able to accept SNAP benefits during a shutdown.

The White House and the Office of Management and Budget (OMB) have a list of federal agencies and their contingency plans in case of a shutdown. Here’s the link: https://www.whitehouse.gov/omb/information-for-agencies/agency-contingency-plans/.
 
CRFB offers readers a history lesson. Here’s an excerpt.
 
How many times has the government shut down?
 
Since Congress introduced the modern budget process in 1976, there have been 20 “funding gaps,” including the 2018-2019 shutdown and the one in January 2018, when funds were not appropriated for at least one day. (The hours-long lapse in appropriations in February 2018, though sometimes characterized as a shutdown, did not result in federal employee furloughs.) However, before 1980, the government did not shut down, but rather continued normal operations through six funding gaps. Since 1981, ten funding gaps of three days or fewer have occurred, mostly over a weekend when government operations were only minimally affected. 
 
There have now been four “true” shutdowns where operations were affected for more than one business day. The first two happened in the winter of 1995-1996, when President Bill Clinton and the Republican Congress were unable to agree on spending levels, causing the government to shut down twice, for a total of 26 days. The third was in 2013, when a House and Senate standoff over funding for the Affordable Care Act (ACA) resulted in a 16-day shutdown. The fourth shutdown in December 2018 and January 2019 – technically only a partial shutdown because five of the 12 appropriations had previously been enacted – centered on a dispute over border wall funding and was the longest-lasting shutdown at 35 days.
 
Kotok’s comments:
 
Let’s get to financial markets. Stock markets and bond markets do not like shutdowns. There are two reasons. First, they are disruptive and there are often negative unintended consequences from the disruption.
 
Secondly, they have a history of never saving any money. In fact, they cost money because the implementation of contingency plans has a cost, and the cost is never recovered.
 
There is a third item which is more obscure. A shutdown demonstrates and confirms the dysfunction of the US government. A shutdown only happens when an extreme faction (either Democrat or Republican) has sufficient votes in their caucus to interrupt the normal and usable budget process. These extremes are found in the minority, but that contingent achieves power when the chamber, whether House or Senate, has a very close margin. This is true whether it is the present-day House Freedom Caucus or a different day with a House progressive caucus like the “Squad.” Extremism is practicing financial terrorism. Either political party’s financial terrorists can be disruptive and dangerous. They are alike when it comes to costing the investment community money. And it is the business world and the workers in our country who ultimately pay when there is injury to the US economy.
 
Bottom line: Extremists, whether from the far right or the far left, are injurious to the health of the nation. As one reader (a Texas Republican who has become disgusted) wrote to me: “They burn down the entire barn while trying to save one cow.”
 
Markets have a way of pricing in the cost of this present potential shutdown, just as they have done in the debt-ceiling fight.

Here’s a chart of the 10-year credit default swap on the US government. The price is back to where it was at the peak of the debt-ceiling crisis (this translates into a higher yield).  Please note that this means interest rates on longer-term US government paper and all federal agency paper are higher than they would otherwise be. The House Freedom Caucus has succeeded in raising interest rates on nearly everybody even as the Federal Reserve has paused its policy changes. The chart below tells the story. Source is Bloomberg data.
 
Also note that we have a cash reserve in our US Equity ETF portfolio. 
 

Source: Bloomberg