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Falling Over the Cliff - Or the Courage to Jump?

December 18, 2012, 07:00 AM

You can't avoid being barraged by the fiscal cliff hype from the media in all its forms. Frankly, it has now become boring. What is hype and what is real? More importantly, what affect would it really have on the equipment leasing and finance industry?  Because let's face it, it's all about us right? Right!

In order to answer this question, we must first understand what the fiscal cliff is all about. The three biggest components that make up the fiscal cliff are the final expiration of the Bush era tax cuts, forced reduction in federal government spending referred to as “budget sequestration”, and the expiration of both the payroll tax holiday (the temporary reduction of the employee portion of social security tax) and the normalization of unemployment benefits that were prolonged during the downturn. I will address each of these three components and provide my opinion about their impact to the lease and finance industry. Please keep in mind that these are my personal opinions and not those of Equipment Finance Advisor, the Equipment Leasing and Finance Association, CSI Leasing, my wonderful wife Diane, or anyone else for that matter. In order of importance, the following are the most impactful changes that become effective in January provided a last minute deal isn’t struck:

1. The across the board tax cuts (for roughly 47% of the population that pays federal income tax) from President G.W. Bush will expire once and for all in January.  Recall, these cuts were set to expire ten years from the date enacted but were extended by President Obama. The marginal rates will go back to Clinton era rates on all tax brackets. It has become dogma to some that higher tax rates were the sole reason for the economic prosperity and balanced budgets during the second half of the Clinton Administration. Heck if higher tax rates alone generate GDP growth and balanced budgets, then in order to create a booming economy why not take marginal tax rates to 80%? I’m just being facetious.

It's thought that the across the board tax increase could generate over $2 trillion in federal revenue over ten years, or $200 billion a year. That amounts to just 6.7% of the roughly $3 trillion in annual federal spending. The impact on 2013’s nominal GDP of roughly $16 trillion is not completely clear since tax payers would not necessarily have spent every dollar they were saving in lower taxes on goods and services. Some of that might have gone to savings or reducing their household debt (which can be considered savings too). So let's say that 50% of the $200 billion in new taxes may reduce GDP by $100 billion.  That would reduce GDP growth for 2013 by 0.67%.  This will hurt no doubt, but based on consensus estimates of around 2% to 2.5% GDP growth, it should not by itself throw the U.S. into a recession. Now there is a strong correlation between GDP growth and capital expenditures (CAPEX). Likewise, there is a strong correlation between CAPEX and the equipment leasing and finance activity. Therefore any reduction in GDP should create some downward pressure on equipment leasing and finance activity, but in my opinion it may not change the financing volume levels we have been dealing with over the past four years and more specifically the last six months of 2012.
Businesses have been increasing cash holdings, cutting costs and improving productivity in every conceivable way since 2008. During the same period, we have been leasing and financing equipment acquired due to the replacement of exhausted gear, for productivity reasons, and to a lesser extent, some modest growth initiatives. However, the energy sector and technology for cloud computing have been exceptions to be sure. I really don't see this level of lease and finance activity changing regardless whether we go over the cliff or not. Equipment ages and ultimately fails. Cloud computing and the energy sector should continue as they fall into the categories of energy efficiency and productivity both of which have positive expense reduction and bottom line benefits. Acting as a little cushion to some downward GDP/CAPEX pressure is the improving housing sector, low interest rates, and the progressive revival of the auto sector. 

2. Government spending cuts as prescribed by the Budget Sequestration take effect in January. This is the $1.2 trillion you keep hearing about. Except, federal government math is different than our math. It's really not a $1.2 trillion.  I have to confess that I actually read the 394 pages of the OMB Report Pursuant to the Sequestration Transparency Act of 2012. Hey, don't make fun of my reading list and I won't make fun of yours.  I love a good comedy and reading some of this stuff has had me rolling in laughter on several occasions. But let's get back to the Budget Sequestration. To put this in perspective, here is an analogy. I am sure that many of you have at some point been forced to be part of a cost cutting exercise at a business. The exercise is always painful but straightforward; you are told that every department has to cut say 9% and not to return until you get there. Imagine what your boss would have said if you came back and said "hey boss, I cut 7%, but, we figure that by doing so we will save the company another 2% over ten years in lower interest expense due to our 7% cut. So there's your 9%". Likely your boss would have just found quicker way to save your department the other 2% by firing you and everyone else on your team who came up with that brilliant idea. So now that I set the stage, please take a look at the table below which is on page 5 of the OMB Report.

Chart - Robert Rinaldi - Total Annual Reduction by Function

They plugged a debt reduction interest savings of almost 20%. So the amount of real spending cuts is not $1.2 trillion over nine to ten years but rather $984 billion, or a little over $109 billion annually out of $3 trillion dollar in spending.  The sequestration cuts are born relatively evenly between defense and non-defense accounts. So we are talking about 3.6% in annual spending cuts. It's a start, but let's get serious, it’s not nearly enough as we are more than $16 trillion in debt and growing at a rate of a trillion per year. So what’s all the commotion for three cents on the dollar in cuts? If you cut a penny from the government, they squeal like stuck pigs period. Now yes, I do appreciate that defense bears the brunt and being a conservative, I never like to think about reducing our defense capability. But hey, as Jesse James was reported to have said when asked why he robbed banks,  'because that's where the money is.'  I am sure there is some amount of waste, excess and inefficiency in that gargantuan budget.  I also understand that one man’s waste, excess and inefficiency is another man's revenue and these reductions will have some knock on affects in the defense industry that will trickle down to Main Street. 

In the OMB Report, starting on page 11 and going for the next 224 pages there is a detail of every budget line item with their annual budget and the amount designated to be cut. As you look into these line items you quickly find that many of the real dollars are "exempted" from the cuts and a smaller amount is available to be cut by the prescribed sequestration percentages. 

Further, if you have the patience to peruse enough of the 224 pages, you will be amazed at why it’s apropos that some use the term "nanny state" when referring to the federal government.

So with all that being said, will the budget sequestration effect net business fixed investment? There may be some downstream effects of the defense cuts on companies providing parts, equipment, and services to the defense industry.  These cuts though will start to impact GDP towards the second half of the 2013 as they will not all hit in January. Realistically, I imagine that Congress and the administration will find ways to skirt or rescind some of these cuts by tacking appropriations onto other unrelated bills that come up over the next nine to ten years. The usual shell game of follow-the-pea will continue.  However, by allowing these cuts to take effect, I believe we will send a strong signal to our business leaders, citizens, the bond market, and even international markets, that we are finally serious about getting our fiscal house in order.   This alone may stimulate business activity and provide confidence that at least we are doing something meaningful to address the national debt and budget imbalances.  The consumer and business confidence factor is at the very root of business spending and GDP growth.  So my answer to the effect on our industry is mixed in the short run and possibly good in the long run.

3. That leaves the expiration of the payroll tax holiday and interminable unemployment benefit extensions. These two creations of the federal government have now become new entitlements. The payroll tax holiday makes the future prospects of Social Security even worse but hey let's kick that can down the road…NOT.  The indefinite length of unemployment benefits does great damage to our labor force and society.  In my opinion, the expiration of these two misguided entitlements will have no appreciable effect on our industry. In fact they may be hurting employers who cannot fill their currently open slots, as evidenced by the lowest job participation rate since 1981. In fact, the job participation rate issue obfuscates the real unemployment rate and gives a false reading of any real progress.  

You have probably figured out by now that I am a proponent of going over the fiscal cliff. I would go so far as to say that the bipartisan bill that created this “fiscal cliff” was probably the finest piece of congressional and administration negotiation that we may have seen in decades. It has been said that a negotiation in Congress works best when both parties are completely unhappy with the resulting bill, yet agree that the final product is what’s best for the country, not themselves. To that end I say, well done and thank you for putting the country first. However if there is a negotiated settlement, the current proposals being floated from each side seem to still arrive at the same rough amount of tax increases and spending cuts.  So why are both parties screaming bloody murder?  Because they are not the ones who decided on what to cut.  They should save their dramatics and energy for the real fun – entitlement reform which is the arguably the biggest problem as it relates to getting the U.S. fiscal house in order.  Let’s not “fall” off the cliff, as that sounds like an accident.  Rather let's have the courage to jump.

A sincere Happy Holidays and New Year to you and yours.


Robert J. (Bob) Rinaldi
Chief Executive Officer | Commercial Industrial Finance, Inc.
Bob Rinaldi is Chief Executive Officer of Commercial Industrial Finance (“CI Finance”), a national equipment finance company headquartered in Cincinnati, Ohio. CI Finance was acquired in 2015 by CBank, a Cincinnati-based community bank focused on commercial and industrial lending to SMBs. CI Finance specializes in the development and implementation of sales-aid finance programs for manufacturers, vendors and distributors of capital equipment.

Rinaldi was SVP of CSI Leasing, responsible for its organic and inorganic growth strategies. Previously, Rinaldi was Executive Vice President of National City Commercial Capital Company (NC4), now PNC, and President of NC4 Canada. Rinaldi has held positions including Senior Vice President of Provident Bank and Executive Vice President and Principal at Information Leasing Corp.(ILC), later acquired by Provident. As a founding partner of ILC, Rinaldi helped grow the company to the fifth-largest bank-owned leasing company in the United States with annual originations of over $3 billion and $8 billion in assets.

Rinaldi is the immediate Past-Chairman of the Equipment Leasing and Finance Association (ELFA), the premier trade association representing the $1 trillion equipment finance sector. He is also a member of the Equipment Leasing & Finance Foundation’s Research Subcommittee and Development Committee. He is a past Trustee of the Foundation and past Chairman of ELFA’s LeasePAC. Rinaldi was the recipient of the Foundation Research Committee’s 2013 Steven R. LeBarron Award for Principled Research and ELFA’s 2014 David H. Fenig Distinguished Service in Advocacy Award.

Rinaldi can be found on LinkedIn and on his website dedicated to the pioneers of the modern equipment leasing industry as we know it today --
Comments From Our Members

Bob Rinaldi • View APN Profile
For those of you who can't get enough of this stuff may find the following report via this URL very interesting. The report is from the Congressional Research Service and it provides greater detail into everything that is expiring in 2012. Personally, I would like to see exactly what goes into these numbers since they toss hundreds of billions and trillions of dollars like they are nickels.
12.20.2012 @ 12:55 PM

Adam Karson • View APN Profile
Bob, great article. For us macro-oriented folks, it’s good to hear views from people “on the ground.” When my firm, Keybridge Research, prepared our 2013 economic outlook for the equipment leasing and finance industry, fiscal policy was one of the major issues we had to confront. You’re right – one way or another, fiscal consolidation is going to take place in 2013 and beyond; and there might be little difference between the fiscal cliff and a compromised deal purely in terms of dollars and cents. Figuring out how this factors into economic growth is, really, part art and part science. For example, I think we generally agree that the direct effects from the fiscal cliff on equipment investment might not be that significant. However, we are probably more worried about the potential loss in confidence from not reaching a compromise. Failure to reach a deal would likely prolong the uncertainty around long-term structural fiscal reforms – uncertainty which we know hurts investment. Also, the process of making fairly haphazard budget cuts (i.e., sequestration) rather than taking a more strategic view on spending could be poorly received by businesses, consumers, investors, and ratings agencies – a negative for investment activity, interest rates, and the availability of capital. Of course, this is one forecast I would be happy to be wrong about – it would mean faster growth in 2013. How do you think our view lines up with what you’re hearing from clients and other lessor
12.20.2012 @ 8:47 PM
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