European Debt Crisis Accelerating … Again!

Oh boy, here we go again! After trying to paper over the problem for several months, the European Central Bank (ECB) is rapidly losing its battle against the debt crisis in the “PIIGS” countries — Portugal, Ireland, Italy, Greece, and Spain.

In the past several days …

* Greek 10-year note yields blew out to a new record high of 17 percent, compared with 7.8 percent a year ago …

* Portuguese yields surged as high as 9.7 percent from 4.6 percent a year ago, while Irish yields hit a new crisis high of 10.8 percent …

* Plus, the crisis spread more aggressively to larger European economies like Spain and Italy. The premium investors demanded to hold Spanish bonds over core German debt surged to a four-month high, while Italian bond yields rose sharply.

Standard & Poor’s put Italy’s “A+” credit rating on negative watch, citing the country’s large debt load (120 percent of GDP) and slowing economic growth. Meanwhile, the Socialist party in Spain was routed in elections. That raised concern the government won’t be able to push through unpopular programs to reduce that country’s budget deficit.

Worse, the European debt crisis is intensifying at the same time that evidence of a U.S. economic slowdown is mounting! So if you haven’t taken protective action yet — or better yet, taken steps to profit — it’s time to get moving!

You Can’t Combat a SOLVENCY Crisis with
Programs to Fight a LIQUIDITY Crisis!

More than a year ago, key policymakers in Europe pushed through a massive $1.1 trillion bailout program to fight what was then a big run-up in yields on sovereign debt in the PIIGS.

Those programs were designed to restore liquidity to the market for government bonds, and to give governments some breathing room. The ECB subsequently extended hundreds of billions of euros in loans against government bond collateral — debts issued by the PIIGS — to keep troubled banks afloat.

Those moves restored some semblance of LIQUIDITY to the government bond market. But the problem isn’t liquidity, it’s SOLVENCY! The governments of the PIIGS countries simply borrowed and spent too much. And now they don’t have the economic growth and tax revenue to pay those debts back at their full face value.

The only real way out of this crisis is to crunch the debts: Haircut the bonds, reduce the countries’ debt burdens, and set the stage for longer-term healthy growth. But the ECB and hundreds of private banks are standing in the way because that would force them to realize billions and billions of euros in losses. That, in turn, would open up huge capital holes in the balance sheets of many banks and lead to outright failures.

So we get this game of “extend and pretend.” It lasts for a while until the crisis gets so severe, that no amount of subterfuge can hold back the flood. Then government bond prices tank, government bond yields soar, and stock markets get hammered across the board.

U.S. Fed Playing Same Game as ECB …
and the Results Are Just as Lousy!

I believe the market action in Europe has major implications for the U.S. down the road. Why? Many of the “solutions” from the Federal Reserve and federal government for the banking and housing sectors have also been designed to restore liquidity. They do NOT solve the real problem — that we borrowed and lent too much money against collateral (houses, commercial real estate, etc.) that is still declining in value.

Is it any wonder, then, that bank stocks are rolling over again?

That the shares of mortgage insurance companies — which make banks whole when borrowers default — are setting new cycle lows?

That home prices are once again plumbing new depths in some markets — and dangerously close to doing so nationwide?

Or that the U.S. economy is slowing fast, as I’ve been telling you the past few weeks?

My recommended responses to these multiple crises are clear and straightforward: Take profits off the table on longer-term investments, and target profits from downside moves in key sectors and asset classes!

Until next time,

Mike