The Pentagon is currently engaged in a marketing scheme which I like to call "Cancel the football program".  Every city and town in America has seen this before. Wherever there is a movement afoot to reign in the school budget because there is a bloated administrative structure or employee benefits have gotten out of control the first thing the entrenched bureaucracy says is they will be forced to cancel the most popular program like football in an attempt to rally support and maintain spending at the same wasteful level as before. As the March 1 sequestration approaches the Pentagon and their congressional supporters (which consists of all 100 Senators and 435 Congressmen) start screaming about weakening our national defense or talk about cutting benefits to our service people or veterans. What they are trying to protect is massive wasteful government spending that goes to their home state or district. We have enough tanks which the army says it doesn't need, or planes that don't fly all that well, or ships that leak. Politicians on both sides of the aisle are talking out of both sides of their mouths when they pretend to be concerned about the deficit caused by runaway government spending. The defense budget contains a large measure of corporate welfare.

Consequently I think a 10% cut across the board is probably a good thing, I would like to see the budget for Congress be included in this sequestration also.

The only ray of hope I see in this mess is people are finally admitting that reduced government spending will cost people their jobs. This has always been the case, it is simple economics. During the campaign it seemed as if the laws of economics were suspended as candidates tried to make people believe reduced government spending would create jobs. It won't. As a country we need an honest debate about economic choices and not live in some la-la land of economic fantasy.

This week the Department of Justice (DOJ) announced they are pursuing Standard & Poor's for fraud because of their behavior during the sub prime mortgage era. The DOJ contends that the rating agency knew the securities they were rating AAA were not that creditworthy and they were influenced by the fees they were collecting rather than any objective analysis. I have been in the bond business for 40 years and an announcement like yesterday's is equivalent to coming down on Christmas morning and finding a pony under the tree. Finally the Feds are saying publicly what every bond market professional believes 100%. The rating agencies were selling ratings to the Wall Street banks with intentional, callous and complete disregard for the investors they claim to be protecting. Bond market professionals have been complaining about the mercenary nature of the rating agencies since I got into the business in 1972. I know it is too much to hope for but I would love to see Moody's be next.

I think across the board cuts in government spending is a good idea. I would argue that a 10% initial cut might be a little heavy but a 5-7% cut I believe would be absorbed by the recovering economy and while it will reduce growth it will not push us into a contraction. Everyone in the country knows we spend plenty of money on defense, education, social security etc., so a reduction should not affect the quality of life. I hope we don't have another last minute session of Congress where the Senators and Congressmen find a way to protect the status quo and try to sell us on the idea that they have actually made progress on the fiscal situation. Cut everybody equally and move on.

How many times are we expected to buy the Brooklyn Bridge? Congress has decided to postpone the debt ceiling debate until May while they work on spending cuts. But this time they are "really, really really, really" going to address the issue. Fat chance. How dumb do we look? I have a better idea, why don't they go into a room and work out the details of exactly what they think we should do in a comprehensive form and present their ideas to the voting public. Is that too much to ask? The argument at the moment is stuck on one side saying "we don't want to pay for the spending we have authorized until you guys cut entitlements" and the other side counters with "we aren't going to do that". So the solution is to delay the confrontation another three months and run to a 24 hours news network and explain how it is not their side's fault.

What is even more unbelievable is the financial press is acting like this time is different.

Same Old / Same Old Department:  According to a NY Times article this weekend three Senators who receive heavy contributions from drug maker AMGEN managed to insert a $500 million price break in the fiscal cliff resolution bill that will be paid for by higher cost for Medicare. So the next time you hear Max Bacus (D- Montana) or Orrin Hatch (R- Utah) or Mitch McConnell (R- Kentucky) talk about cutting the deficit or fiscal responsibility you will know they mean it for everybody but the drug company that owns them.

Like most Americans I am fed up with the Senate and the House of Representatives. Over the years they have passed spending bill after spending bill and now they want to debate whether or not we should pay for the programs they instituted. If they don't want to pay for them then they should cancel them. How hard is this? Don't try to sell me some nonsense about fiscal responsibility, if Congress were fiscally responsible we wouldn't be having this discussion. The country has bigger issues than a made for TV drama about the debt ceiling.

There are signs of intelligent life starting to emerge, even on Wall Street. The board of JP Morgan has reduced Jamie Dimon's comp because of the trading loss in London. It is difficult to feel bad for someone who has to struggle through the winter on only 11 million dollars but the fact that the London loss was his fault and it is recognized as such publicly is a step in the right direction.

The US economy feels a little sluggish which I believe is due to all the noise about the "cliff". I believe the real estate sector will continue to improve, the earning of major US companies will be fine and the private sector will expand as the recovery continues. Congress has just approved a 60 billion stimulus package in hurricane relief and any spending cuts that Congress manages to pass will be minor. It is almost like the current uproar about gun control will give the politicians in DC the perfect cover to avoid any real progress on the deficit. In an ideal situation, the recent minor tax increase combined with a minor reduction in government spending, plus an improving economy should create better deficits numbers by year end. Stay tuned.

On Monday December 31, 2012 I bought some call options on the S&P 500 (SPY) because in the midst of all the noise about the fiscal cliff I believed that Congress only cared about how bad they would look if they did nothing. I am pretty sure Congress doesn't think in terms of what is good for the country they only think about what is good for Congress. I thought that if they did something (anything) the stock market would react on the upside only because Congress wasn't totally dysfunctional. This morning I sold the options for a profit. I did it as soon as the market opened because I think once the markets realized how little the House and Senate managed to do the rally would fizzle pretty quickly. This is a pretty silly way to make investment decisions.

2013 will be a difficult year for the markets. I expect:

The political situation remains confused and contentious and rancorous and ineffective.

Bond yields will remain low but there will not be the price appreciation witnessed over the last few years.

Stocks should be everyone's first choice and if the politicians don't manage to kill the economy, equities could be in line for a solid year.

With low interest rates I expect the housing sector will continue to improve.

Private sector credit quality will continue to improve and municipal sector credit quality will continue to slide.

I think John Boehner is done as Speaker of the House

No matter what deal is finally agreed to by the politicians in Washington it will act as a brake on the economy. Reduced Government spending and higher tax rates for the wealthy will lower the national growth rate. This is not complicated, it is simple economics. One would hope the negotiators would be sensible enough to pick a target growth rate and try to craft an agreement that will start to solve some of our long term issues without suppressing the economy too much. The effects of misplaced aggressive austerity measures can be seen in Europe where there is bubbling civil unrest because the economies are contracting. The contracting economy decreases the opportunities for the unemployed and the young people entering the work force while reducing government tax revenues. The solution to massive budget deficits and runaway government spending will take a long time, it cannot be corrected in a year.

For all you fans of financial scams, next year should be a banner year. Pay particular attention to "crowd funding" and "non-publicly traded REITs". I believe both of these are "unborn sorrows ripe in fortune's womb" to quote the Bard. When these scams finally land we should think about going after regulators who should be on the case but once again are MIA. One of the regulatory bright spots in 2012 is the retirement of Mary Shapiro. Mary, who held significant positions at FINRA before moving to the SEC, proved just as ineffective at both agencies. I can't think of any financial scandal that occurred during her tenures that she had any clue was coming. If any reader knows of any, please let me know.

As the year draws to a close I have some random thoughts about the economy;

I believe we are going to go off the "fiscal cliff". This is a bet on the inability of Congress to agree on what day of the week it is rather than any analysis of our economic situation.

I think it is time for the leadership of the House of Representatives to lay out their fiscal plan in mind numbing detail. This would start a much needed debate about the direction of the country.

I think the economy is doing better and the real estate market is showing signs of life. The American voter will always vote the economy so the takeaway from the election is that most people think the economy is doing well and are optimistic about the future.

I don't think going off the "fiscal cliff" will be that devastating. It will certainly be deflationary and push the economy towards a recession but since I believe the economy is stronger that the talking heads on TV are saying I think the country will skirt a recession and stay in positive territory. It will be close.

I think that nothing has been done about the Greek crisis other than that some near term liquidity has been provided. Two years ago I was quoting a senior government trader as saying it is a "liquidity solution to a solvency problem" and that is still the case.

I believe next year will see Italy join the ranks of bailed out Euro members.

I think 2013 will be a pivotal year for the municipal bond market as financial stress on cities, states and local entities will change the way the market looks at credit quality. I expect more Chapter 9 filings, more privatization and more conflict with public employee unions. How it shakes out is anyone's guess, stayed tuned.