Rarely in history can we look toward the immediate horizon and see a future event that is virtually certain, very dangerous, and totally underestimated by the majority of the population.
Yet that's precisely the situation we face with a new fiscal fiasco under the Super Committee of Congress.
The 12 committee members (six Democrats and six Republicans) have to find some way to cut $1.2 trillion from America's out-of-control budget deficits.
They have to gut spending or jack up taxes — actions that prominent members on both sides of the committee have publicly vowed never to accept.
And they have to do it all in just nine days.
They meet deep below the Capitol in a red-carpeted room. They sing together. They throw sticks and stones. And then … they just pray.
Because they know that, even if they can somehow reach a meaningful compromise, it's going to be almost impossible to sell the deal to their colleagues in Congress … and beyond impossible to sell it to their political base, whether on the left or the right.
The Los Angeles Times says they're in "deadlock" and at an "impasse" — with the stalemate revolving around precisely the same issues that have stunted such efforts all year: Republicans drawing a line in the sand against the new revenues that Democrats insist on … and Democrats writing in blood that they cannot cut entitlements without them.
Politico says "failure could shake confidence in world markets and spark automatic cuts across the federal government starting in 2013."
Rep. Jeb Hensarling, the leading Republican on the committee, blames Democrats for their insistence that tax increases be coupled with reforming health care programs, while …
Senate Majority Leader Harry Reid dismisses the latest GOP offer as a "phony deal."
No one has any realistic hope that the Super Committee will strike a meaningful deal. And even if they do, no one thinks they'll be able to sell it to the full Congress.
End result: Expect major new downgrades of U.S. debt by Moody's and Fitch for the first time … and by Standard & Poor's (S&P) for a second time!
What Are the Consequences?
Here's a Sneak Preview …
Imagine this scenario: A major government has been forever borrowing from Peter to pay Paul, never lifting a finger to cut its deficits.
Suddenly, global investors pull the plug: They dump the government's bonds like a hot potato. They drive bond prices into the gutter. And they make it impossible for the government to borrow another cent without paying sky-high, budget-busting interest rates.
To persuade investors to resume buying its bonds, the government is eventually forced to pass Draconian austerity measures — mass layoffs of police and other public employees … deep cuts in pensions and health benefits … plus tax hikes across the board.
Result: Mass protests, riots, and national strikes … another big blow to the economy … a new exodus by investors … and louder demands for even greater cutbacks or taxes.
Sound familiar? It should — because that's precisely what we've just witnessed in Greece. Meanwhile, Italy is heading down the same path, passing Draconian austerity measures just this weekend.
Sure, global investors rejoiced. But even while Rome was performing emergency surgery, the European debt cancer had metastasized to an even larger economy — France, the next likely victim of the debt contagion.
Suddenly, French bonds had plunged; and suddenly, the interest premium the French government would have to pay for 10-year money (compared to the German government) had surged to 168 basis points (1.68 percentage points).
What's worse, the cost of insuring French government debt against default had also gone through the roof!
To help understand exactly what this means, let's say you've been buying French government bonds for yield and safety.
To protect yourself against a future default, you can buy insurance in the form of a "credit default swap."
As with any insurance, if the risk of failure is low, your premium cost will be low; if the risk surges, your cost will surge. And that's precisely what we've just seen happen with the default insurance premiums on French government bonds:
Right now, to insure $10 million in 5-year French government bonds against default, you'll have to pay $203,001 in yearly premiums. That's DOUBLE the peak level during the debt crisis of 2009 and TRIPLE the peak of 2008!
How bad is that? For the answer, look at Greece and consider these facts …
Fact #1. Three years ago, around the time when the Greek debt crisis first burst onto the scene, if you wanted to buy the equivalent insurance to cover a Greek default, you would pay only $174,761 (the exact cost of a 5-year Greek credit default swap on November 19, 2008, according to Bloomberg data.)
That's $28,240 LESS than what investors are paying for French default protection today!
In other words, according to the market for default insurance, French bonds today are RISKIER than Greek bonds were at the onset of the Greek debt crisis!
Taken in isolation, are French government finances really weaker today than Greece's were three years ago? Perhaps not. But its banks are far weaker. And so Europe as a whole! Therefore, the markets see these new risks as important factors that dramatically increase the threat to investors in French bonds.
Fact #2. S&P, Moody's and Fitch are apparently ignoring these new risks, choosing to grade the French government as if it were an island onto itself:
Result: They still give France a triple-A rating today, far higher than the single-A rating (or lower) which they gave Greece three years ago.
In sum …
• The markets say French debt is RISKIER today than Greek debt was three years ago. But …
• The major rating agencies say French debt is far SAFER today than Greek debt was three years ago.
Who's right? The markets or the rating agencies? That leads me to …
Fact #3. In its Moody's Analytics of October 6, 2011, Moody's graphically admits that, when it came to evaluating the true risk of Greek debt, the markets were right and Moody's was wrong.
Here's Moody's chart to prove it:
The lines and scales are from Moody's original; the titles and text are mine. In any case, the chart clearly shows that the true rating of Greek bonds — as implied by their market price and the cost of default insurance — fell a lot sooner and a lot lower than Moody's rating.
In other words, Moody's grossly and consistently overstated the safety of Greek bonds.
It wasn't until Greece was on the brink of near certain default that Moody's eventually caught up to the market reality.
But for investors, that was far, FAR too late. Banks and individuals who relied on the S&P, Moody's and Fitch ratings lost hundreds of billions of dollars.
Are the rating agencies making the same mistake with France? For the answer, consider …
Fact #4. Last week, S&P sent a notice to its private subscribers stating that its AAA rating of France was on the chopping block; that a downgrade was in the works.
France reacted with great outrage. And, surprisingly, S&P responded by sheepishly stating that the message was an "accident."
But no matter who or what pressed the wrong buttons, where there's smoke there's fire. And given the clear market signal that risk on French debt is surging, the true outrage is that S&P is still telling the public it's not preparing to downgrade France.
Fact #5. S&P, Moody's and Fitch accept large yearly fees from debt issuers in order to assign them credit ratings. Bluntly speaking, their ratings are bought and paid for by the very same institutions they're rating.
If they downgrade countries like France, they must also downgrade banks and other on-the-brink institutions that depend on those countries for bailouts. But those institutions are some of their best customers, paying them the biggest fees!
This is an egregious conflict of interest and helps explain WHY they're so reluctant to downgrade countries like Greece or France, delaying the appropriate action for months or even years.
(For more on the dark causes and dire consequences of these conflicts, see The Weiss Ratings Challenge.)
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Fact #6. At Weiss Ratings, we give France a C (approximately the equivalent of a BBB+ by S&P).
Unlike S&P, Moody's or Fitch, we never accept a dime from debt issuers for their ratings. We have no conflicts of interest. And we never delay downgrades for financial or political reasons.
As I explained in my report of October 31, one reason France still gets a unanimous triple-A from S&P, Moody's and Fitch is because the rating agencies are afraid to rock the boat.
The rating agencies know that, without the triple-A ratings, France would be disqualified from contributing to the European bailout fund and the entire European rescue plan would fall apart.
They also know that, in that scenario, their very best customers — the banks that pay them huge fees for their ratings — would collapse.
And they know their own revenues would plunge in the resulting chaos.
At Weiss Ratings, we base our grades strictly on the facts, and those facts tell us that France fully merits its C rating:
* France, along with Germany, is the keeper of all their deadbeat brothers and sick sisters — not only in the euro zone, but also in Eastern Europe.
* France's banks hold the bulk of the bad government debts.
* France's treasury is now burdened with the bailouts for both the wayward banks and the sickly governments.
* And France also has a big pile of government debts of its own to refinance.
One more key point: Unlike the triple-A of the other rating agencies, our C rating for France IS in sync with the rising cost of default insurance on French debt.
Fact #7. The Greek debt crisis has shaken the global marketplace to its foundations. But the French economy is over EIGHT times larger than Greece's. So its debt problems are likely to have at least eight times greater impact on global financial markets than Greece has had.
Wondering how this impacts you? Then consider what Weiss Research's Mike Larson has to say about what's likely to happen next …
How and Why This Crisis WILL Strike the U.S.
by Mike Larson
After France, the U.S. could be next victim of the contagion.
Look. In Europe, the fundamental, underlying cause of the disaster is debt — huge government debts — precisely the same problem we have in the U.S.
In Europe, the trigger that torpedoed their markets was the realization that their politicians are incapable of overcoming their debt challenges: If they make their voters happy, they're attacked financially by their investors in the marketplace. If they make their investors happy, they're attacked PHYSICALLY by their voters in the streets.
That's also precisely the Catch-22 dilemma we're seeing in the U.S.
In Europe, the consequences are massive ratings downgrades, a collapsing economy, and crashing financial markets. And that's essentially what I see happening here as well.
I see a chain reaction of events with three major consequences:
First consequence: If the Super Committee fails to reach an agreement, the law mandates that across-the-board cuts will be implemented — split evenly between defense and domestic programs.
The defense budget will be cut by $492 billion — nearly a half-trillion dollars. U.S. Defense Secretary Leon Panetta has called further defense cuts "nuts," while Army Chief of Staff Gen. Ray Odierno says he is "deathly afraid" of this outcome.
Plus, another $492 billion will be cut from health, education, drug enforcement, national parks, agriculture programs, and Medicare.
For government agencies and for a public that's addicted to the money that normally flows from Uncle Sam, the cuts will be TOO MUCH, TOO SOON. They will drive the housing market even deeper into the gutter. They will push unemployment higher. They will add to the downward momentum in the economy.
But for global investors, who are hoping the U.S. can avoid the fiscal disasters that have hit Greece and Italy, the cuts will be TOO LITTLE, TOO LATE! They will take one look at the still-bulging deficits in the U.S. and dump risky U.S. securities, just like they've been dumping Spain's and Italy's.
Second consequence: Just as in Europe, the failure of the U.S. Congress to deal pro-actively with the deficit will set off a whole new round of earth-shattering downgrades of the U.S. government's credit rating.
In fact, Moody's itself has said that the reason it did NOT cut America's AAA rating in August was precisely because it was waiting to see if the Super Committee could come up with more deficit reductions. If the Super Committee doesn't come through on November 23, it sends the message that Washington is incapable of acting — a message that will almost surely result in mass credit downgrades by all the major agencies.
Merrill Lynch agrees: "The credit rating agencies," writes Merrill, "have strongly suggested that further rating cuts are likely if Congress does not come up with a credible long-run plan. Hence, we expect at least one credit downgrade in late November or early December when the Super Committee crashes."
Third consequence: Another round of downgrades will crush the U.S. stock market. So don't let the recent rallies fool you! Just look at what happened last time:
The Dow plunged 635 points in a single day and 2,000 points in two weeks. Bank stocks fell 30%. The price of junk bonds plunged 10%. Credit markets all over the world went wild.
This time, it could be worse.
Why?
Because last time, the other rating agencies did not follow S&P. So the Obama administration was able to single out S&P for ridicule and attack. This time, the downgrade is likely to be unanimous among all three major agencies.
Because last time, there was hope Europe would solve its debt troubles. Now that hope is also being dashed.
And because this time, the U.S. economy is in worse shape. After adjusting for inflation, the average household income of Americans has plunged far MORE during the so-called "recovery" since 2009 than it did during the recession of 2008. And the average duration of unemployment just hit 40.5 weeks. That's over twice as bad as during the last recession. And it's the highest in recorded history.
Our recommendations are simple:
First, use sharp stock market rallies like we saw late last week to get rid of the stocks that are going to get hit the hardest, such as the ones that are already disappointing investors.
Take Amazon.com, for example. Its earnings came in a mind-numbing 41% below expectations, leading to the largest one-day plunge in over six years! Or look at Goldman Sachs, which reported a net loss of 84 cents per share — 12 times the seven-cent loss expected.
In addition, Ingersoll-Rand announced that its earnings will be far weaker in October, November, and December. Whirlpool, FedEx, Best Buy, and 3M have also warned that their earnings will likely disappoint in the final three months of this year.
That's why I'm telling investors to get their money to safety.
Second, put that money away in a safe place. (To monitor the safety of your bank or insurance company, go to www.weisswatchdog.com. Sign in, add the institution to your Watchlist, and check its Weiss Rating.)
The third step is to go for the profits.
The key is this: When S&P downgraded Uncle Sam last August, you could have bought a simple bet on the falling Dow for just $380 and reaped a gain of 224% in just 47 days.
Another bet on the S&P soared 399% … and yet another, more highly leveraged one skyrocketed 629% in that same period of time.
Even if you capture only a fraction of these moves, you could do extremely well. And if I'm right that the decline after the NEXT downgrade will be far greater, all bets are off! The profit potential is incalculable.
No matter what, however, your first priority should be SAFETY!
Best wishes,
Mike and Martin
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