Getting Rich from the Fiscal Cliff.

A product of congressional can-kicking, the fiscal cliff is a nasty combination of government spending cuts and tax hikes beginning in 2013. As with most cliffs, driving off it will hurt. And even if we survive the fall, we’ll land back in Deep Recession, that seedy, stagnant town we thought we’d left in the rear-view mirror.

“Regardless of ideology, virtually all economists agree that going over the fiscal cliff will tip us back into recession.” — Morgan Housel, explaining the fiscal cliff to readers of The Motley Fool.

So what’s an investor to do?

Let’s look back at the last time we drove off a cliff. The housing cliff. We didn’t call it a “cliff” back then. We preferred slightly slower-moving concepts such as crisis, crash, collapse, meltdown, scandal, fiasco and total f*$# up. In retrospect, though, the housing crash was a cliff. And from its lofty edge, without even a tap on the brakes, flew Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual, Wachovia, Countrywide, AIG, Fannie Mae, Freddie Mac and a slew of other institutions. It was a cliff all right. Some fell hard and exploded into a million flaming pieces, like Lehman Brothers. Others fell hard but their landing was government cushioned, leaving them comatose, crippled and on life support, like Bear Stearns. Still others fell hard but received even greater cushioning, winding up merely in intensive care, embarrassed and unable to pay their medical bill, such as AIG.

But not every institution investing in the housing market flew off the cliff. On the contrary, some institutions and investors profited. And profited big. Examples of such profiting are found during every major market down turn. From the mega-yachts named “Irrational Exuberance” during the dot-com crash to the breathtaking CDO bets recounted by Michael Lewis, we’ve learned that one investor’s death spiral is another’s ticket into the 1%:

Or in the case of hedge fund manager John Paulson, ticket to the .0000000001%. Mr. Paulson is perhaps the most famous example of an investor profiting by betting in favor of a crash. His bets against housing gained $15 billion in a single year. But there have been many others, including those described in Michael Lewis’s The Big Short. The hard part is mustering the guts necessary to bet that a massive market failure will occur, even while countless powerful people vigorously try to prevent it.

Betting that the fiscal cliff will happen involves, among other complex factors, predicting the actions of politicians. While most politicians may want to prevent another recession, they are operating in a largely gridlocked and dysfunctional Congress. The cliff itself is a product of that gridlock. Predicting the actions of a dysfunctional Congress is difficult. A fair dose of luck is needed. Nevertheless, it seems the odds are stacked against the fiscal cliff happening. There are too many powerful people trying to prevent it. As Morgan Housel explains:

“Now, almost no one wants the fiscal cliff to happen, particularly in its entirety. There’s something in it for everyone to hate: tax hikes if you’re conservative and spending cuts if you’re left-leaning. Both parties have voiced their desire to avoid the cliff by making a deal to extend current policies, if only in parts. Odds are that will happen with a last-minute deal hammered out just like last summer’s debt-ceiling deal. Goldman Sachs puts the odds that a deal won’t be made at just 35%. Moody’s puts the odds of failure at 15%.”

Betting that the fiscal cliff will happen is thus rather risky. And those financial advisors who wager most or all of their funds may find themselves relying on one of the many escape routes developed to address catastrophic investment decisions:

If the fiscal cliff does happen, however, Bullzie will not be the only one minting money. Out there now, with or without the help of Goldman Sachs, are hedge fund managers developing clever ways to profit if the economy drives off the cliff. They are short, our fiscal cliff.

Published by Jeremy L. Bartell

Financially Regulated is published by Jeremy L. Bartell, a long-time admirer of Wall Street and its interesting cast of regulators. Jeremy is an attorney with Bartell Law in Washington D.C. He represents financial professionals nationwide in Finra inquiries and investigations, Finra arbitration, securities employment disputes and registration and disclosure matters.