Preparing for the plunge: How the fiscal cliff situation could escalate

More likely than not, Congressional Republicans and newly re-elected President Barack Obama will carve out some form of deal before the year's end that pushes forward the planned tax increases and spending cuts – the "fiscal cliff" – into the spring. Ostensibly, such a "grand bargain" will be designed to give U.S. politicians more time to settle final details, but some observers and voters fear that this scenario would be a replay of the kind of short-term legislative governance that has defined Congress for the past several years.

Regardless of the final details, between now and President Barack Obama's signature on a future resolution bill the U.S. economy will be subjected to market volatility due to the possibility that the president and his opposition will not be able to reconcile their differences before the scheduled sequestration cuts and tax hikes. If this happens, all bets are off on the result.

The closest comparison one can make to a potential negotiations meltdown would be to the Congressional vote on September 29, 2008, when legislators, in a close vote, rejected the terms of then-Treasury Secretary Hank Paulson's Troubled Asset Relief Program. As a result, the market plummeted 778 points and wiped out $1.2 trillion in market value.

Could this happen again? The Republican caucus was substantially more moderate in those days, leading to more opportunities for bipartisan support of ideas. In today's hyper-polarized environment, due to President Obama's insistence on higher revenues and Congressional Republican resistance to raising taxes, talks between the two parties could go sour.

If this occurs, it might trigger credit ratings downgrades on U.S. government debt. During August 2011, Standard & Poor's cut the United States' top-level AAA rating to AA+, though Fitch and Moody's, the two other agencies in the industry, have maintained their grades. This could change if U.S. leaders signal an unwillingness to avoid the fiscal cliff, which would reduce economic output significantly even in its first year.

If you're a U.S. investor with a stake in the stock market, you might want to consider hedging your wealth against a potential financial wipeout if a fiscal cliff deal collapses. Cash flow real estate, which involves buying rental homes in competitive areas, offers steady returns without the volatility of day-to-day share trading. Check out today and get your hands on a helpful "Free Game Plan Report."