October 23, 2011: The Next Big Day of Reckoning

This coming Sunday, October 23, will go down in history as one of the most important days of the 21st century.

On that day, the leaders of 27 European countries will meet. They will announce a new master plan to save Europe. And then they will pray.

If their plan is not good enough, U.S. Treasury Secretary Timothy Geithner warns that Europe — and the entire world — could face “cascading default,” “bank runs,” and “catastrophic risk.”

Polish Finance Minister Jacek Rostowski says the euro-zone crisis is already suffering “a run on the sovereigns” — a mass exodus by investors from sovereign bonds.

French President Nicolas Sarkozy and German Chancellor Angela Merkel also openly admit the vast challenges they face. They know they have just six days left. And they know that before their time is up, they must find a way to …

• put Greece out of its misery with an “orderly default” …

• expand the firepower of Europe’s bailout fund for Spain, Italy and other European countries on a collision course with default, and …

• pump massive amounts of capital into European megabanks on the brink of collapse.

On October 23, Europe’s leaders hope they can do ALL this in one fell swoop.

But don’t be fooled!

Any New European Rescue Plan, No Matter How Big and Bold, Is Bound Cause an Even Greater Debt Catastrophe

Here’s why …

First, they’re running out of time! The crisis is already too far gone — Greek bonds trading at 40 cents on the dollar, Spain and Italy in a death spiral, and massive damage to the continent’s megabanks already done.

They can’t turn back the clock. And they’re nearly out of time.

Second, not enough money! The PIIGS countries alone have over $4 trillion in debts, much of which they’ll never be able to repay. And Europe’s troubled banks have far more.

This leaves a gaping hole that’s so large, even the richest countries in the world could not possibly fill it without gutting their own finances.

In fact, European leaders are trying so desperately to figure out where to get all that money, they’ve even asked emerging market countries to chip in.

Third, no way to stop a vicious cycle already in motion! Before they can get a dime of bailout money, the PIIGS countries must promise to drastically reduce their budget deficits.

Result: They’re forced to cut their government spending, crush their economy, kill their corporate profits, drive down their tax revenues, and, in the end, create even larger deficits.

This is why Greece is sinking so fast. And this is why, despite its Draconian austerity measures, Greece’s deficit for the first nine months of 2011 actually GREW to 19.2 billion euros, compared to 16.65 billion euros last year.

And this is also why we’re seeing similar vicious cycles in nearly every borrower that may need a bailout — not just banks but entire nations … not merely countries like Greece and Portugal, but also far larger economies like Spain and Italy … not just PIIGS countries, but also countries in Eastern Europe and elsewhere.

Fourth, expect many more credit downgrades!

As I showed you here last week, the countries and institutions downgraded by the major credit agencies in the last two weeks alone have $7.3 trillion in debts outstanding (see chart below).

Countries and Institutions Downgraded in
Past Two Weeks Alone Have At Least
$7.3 Trillion in Total Debts Outstanding

But the most shocking news about this crisis is not how often banks and governments have already been downgraded … it’s how many MORE deep downgrades are now on the way!

How do we know?

Because the credit agencies themselves have warned that most of the downgraded countries are now on the chopping block for still more rating cuts.

Because the government bonds of countries like Spain and Italy are already trading at prices that imply far lower ratings.

And because the cost of insuring those bonds against default has already surged to levels that also signal far lower ratings.

Moody’s itself admits that these kinds of market indicators can often warn you about coming troubles far sooner than their own ratings!

Hard to believe?

Then look at this chart from Moody’s Analytics (October 6) on the company’s sovereign debt ratings of Greece. (I’ve added the titles, but the underlying chart is from Moody’s.)

The analysts at Moody’s Analytics have plotted Greek bond prices on a scale that reflects the implied rating bond investors are assuming (the green line in the chart).

Plus, they’ve done the same for default insurance premiums on Greek debt (brown line).

Well, guess what! This chart shows that …

1.) Bond investors first “downgraded” Greek debt in a big way back in the fall of 2008.

2.) Default insurance traders followed with their big “downgrade” about a year later, toward the end of 2009.

3.) Moody’s itself didn’t announce its first major downgrade until the late summer of 2010 — nearly two years after the bond markets.

4.) And it wasn’t until this summer — nearly THREE YEARS after the first bond market signal — that Moody’s finally caught up with reality, downgrading Greece to Ca.

We’ve seen a similar pattern of falling behind reality at S&P and Fitch … with their ratings on countries, banks, big manufacturing companies, municipal bond insurers and many more. (For the evidence, see the case studies in my article of May 10, 2010.)

The lessons to be learned: When countries, banks, or any other borrower is in a death spiral …

• Moody’s and the other major rating agencies rarely give an advance warning. Instead, they lag far behind the markets.

• Eventually, they catch up with reality. Unfortunately, however, by that time, the debt is already a disaster zone and most investors have already suffered massive losses.

• If you see a country’s bond prices plunge in the open market, it can be a reliable early indicator of surging default risk.

• And if you see default insurance premiums following a similar pattern, it can be a very reliable confirming indicator. That’s why we report regularly on both here in Money and Markets.

Bottom line: These danger signs are exactly what we’ve been telling you about each week for countries like Spain, Italy, Belgium, France and EVEN GERMANY!

Why is this so important? For one simple reason:

The bigger the rescue package announced on October 23, the bigger the damage to the finances — and to the credit ratings — of the countries that must finance the rescue!

And the more their credit ratings fall, the more expensive it will be for them to raise the money.

Ultimately, even the rescuers will need a bailout of their own, but none will be forthcoming.

This is why the cost of default insurance for France and Germany is now indicating a far higher default risk than it did even during the debt crisis of 2008-2009.

This is why the bonds of most European governments have been plunging in spite — or even because — of the tall promises we’ve been hearing in recent days.

And this, my friend, is why even the “mother of all bailouts” — or whatever is announced on October 23 — cannot, I repeat CANNOT, save Europe or the euro!

Yes, politicians may persuade some folks that they’ve “finally put this crisis to rest,” as they’ve done so many times before.

And yes, Wall Street may rejoice temporarily, as they’ve also done many times before.

But that’s not the same as stability. It’s not even enough to kick the can down the road. Quite the contrary, with both Europe and the U.S. now caught in a great debt trap, all the evidence indicates that the fanfare and hoopla are nothing more than a set-up for the next major collapse.

My recommendations:

Step 1. Consider any stock market rally — in anticipation of, or in reaction to, the October 23 Europe rescue package — a trap to avoid.

Step 2. Use any such rallies as opportunities to SELL your most vulnerable shares.

Step 3. To help determine which of your stocks are likely to be the most vulnerable, use our Weiss Watchdog. You can access it from the menu bar at the top of www.moneyandmarkets.com or you can point your browser to www.weisswatchdog.com.

Step 4. Also use Weiss Watchdog to check the safety of your bank, credit union or insurance company.

Step 5. Once the bulk of your money is secure, think seriously about seeking the massive profit opportunities that can be created by precisely this kind of crisis.

Good luck and God bless!

Martin