Day of Reckoning! TOMORROW!

Beware!
Within the next few days, Washington and Wall Street may mount a new, sweeping PR campaign designed to deceive investors about the crisis.

Deception #1. If Congress raises the U.S. debt ceiling tomorrow, they will try to convince you that the crisis is “over” — that they have largely “solved the problem” and that we can go back to “business as usual.”

Nothing could be further from the truth!

Our entire Weiss Research team has maintained all along that the debt ceiling would probably be raised in the 11th hour.

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But we’ve also told you that no matter how much (or how little) is cut from the federal deficit, nothing can be done to change this fact of life:

The more the government cuts deficit spending, the more the economy will shrink … and the more the economy shrinks, the bigger the deficit will be.

This is the same vicious cycle that’s afflicting Greece, Ireland, Portugal, Spain, and Italy. And it’s the same one that we’ve seen many times during the decline of great nations.

When Will This Vicious Cycle
Be Striking the United States?

It already has been.

Local and federal governments have already been cutting back, and the U.S. economy has already begun to sink back into a recession.

In fact, the government’s GDP report this past Friday proved that this vicious cycle has actually been under way at least since the beginning of the year.

What’s the near-term solution? Sorry, there is none.

The cycle of contracting GDP and contracting government is the natural, inescapable consequence of the toxic assets and debts accumulated over many years.

It’s caused by the build-up from past overspending, past overborrowing, past abuse, and past neglect.

Think about that. It’s obvious that no one has a time machine to go back and change the past. So it should be equally obvious that the only way out is many years of collective sacrifice, belt-tightening, and financial pain.

Starting when? The big message of the debt ceiling crisis in Washington — no matter how it’s resolved tomorrow — is simple: The pain starts right now. The day of reckoning is not next year or 10 years from now. It’s today.

TODAY is the day the U.S. government is being forced to cut back even while its earlier efforts to revive the economy are already failing.

Never forget: The only reason the U.S. economy did not sink into a deeper recession two years ago was because the government pumped in trillions of dollars of stimulus and bailouts.

So now here we are, with the economy faltering again, and guess what! Instead of pumping in more money, our leaders have had no choice but to do precisely the opposite: They’re cutting! They’re taking money OUT of the economy!

For corporations, that means falling profits.

For average Americans, it means more lost jobs.

And for Uncle Sam, it delivers an instant double-whammy — plunging revenues from income taxes and surging costs for unemployment benefits.

Result: A much BIGGER deficit than anyone dreamed possible! Despite any budget cuts!

Deception #2. When S&P, Moody’s, and Fitch downgrade the U.S. government’s debt, Washington and Wall Street will try to convince you that it’s not going to have much impact.

False!

Standard & Poor’s has already said that the downgrade will directly impact government-owned and government-sponsored agencies: Ginnie Mae, Sallie Mae, Fannie Mae, Freddie Mac, and many more.

S&P has also promised that a U.S. debt downgrade could precipitate downgrades of up to 7,000 municipalities.

What they have not told you is that many corporate bonds could also be subject to downgrades.

Why? Because the companies that issue these bonds rely on U.S. government subsidies, contracts, financial guarantees, bailouts, and more. Or they do business with other companies that rely on the U.S. government.

And in a broader sense, they operate in a country — the United States — where the government’s credit rating is a key factor in virtually every financial transaction.

So a downgrade for the U.S. government is inconceivable without a chain reaction of downgrades in virtually every business sector.

Plus, there’s one more explosive fact that S&P has chosen not to highlight in public:

The Impact of a U.S. Debt Downgrade on the
Ratings of Thousands of Banks and Insurers

Throughout modern history, thousands of U.S. banks and insurers have held large portfolios of U.S. Treasuries, government agency bonds, municipal bonds, and corporate bonds.

And almost invariably, it has been assumed that, with the exception of junk bonds, these holdings were a key factor in helping the financial institutions get better ratings.

What happens to their ratings if a substantial percentage of their bond holdings is downgraded? The answer should be obvious: The financial institutions themselves must ALSO be downgraded.

Result: Mass downgrades for thousands of U.S. banks, credit unions, and insurance companies.

How vulnerable are they to this collective disaster? The table below, based on the Fed’s latest data, gives you the answer in a nutshell:

Why Ratings of Thousands of U.S. Banks and Insurance
Companies Are Vulnerable to a U.S. Debt Downgrade

Data source: U.S. Federal Reserve’s Flow of Funds Accounts of the United States. For banks and S&Ls, the numbers shown combine the totals from the Fed’s tables L.110 and L.114. For credit unions, see table L.115. And for insurance companies, see tables L116 and L117.

Start with their holdings in Treasury securities. According to the Federal Reserve, banks and savings & loans hold $216 billion; credit unions have $21 billion; life insurers have $156 billion; and property-casualty insurers have $93 billion.

Total Treasuries held by U.S. financial institutions: $486 billion, a very substantial sum.

But those holdings are small in comparison to what banks and insurers have piled up in bonds issued by a raft of U.S. government agencies: Banks have $1.5 trillion, according to the Fed. Credit unions — $162 billion. Life insurers — $386 billion. And property-casualty insurers — $116 billion.

Total government agency securities held by U.S. financial institutions: A whopping $2.2 trillion, all of which will be immediately subject to downgrades by the major rating agencies as soon as the U.S. loses its top-notch credit rating.

And that’s STILL not the end of it.

U.S. financial institutions also have $725 billion in municipal bonds and $2.9 trillion in corporate and foreign bonds, most of which would probably also be subject to downgrades over the next few months.

All told, U.S. financial institutions now hold an astonishing $6.3 trillion in securities subject to immediate or future downgrades in the wake of a U.S. government debt downgrade.

Of course, the banks and insurers invest in other things besides government and corporate bonds: Mortgages, commercial loans, and more add up to total financial assets of nearly $19 trillion.

It remains to be seen what percentage of those assets will also wind up on the rating chopping block. But even assuming those other assets never wind up on the ratings’ chopping block, here’s the bottom line:

A whopping ONE-THIRD of all the financial assets of all U.S. financial institutions is potentially vulnerable to mass downgrades.

Bottom line: If folks in Washington or Wall Street try to tell you this isn’t a big deal, tell them to take a hike.

What You Should Do Right Away …

The instructions I gave you last week are unchanged:

First, unload and avoid all medium- or long-term government securities — including those issued by the U.S. Treasury, Ginnie Mae, Fannie Mae, Freddie Mac, or any government agency.

Right now, their notes and bonds are still fetching premium prices in liquid markets. But that could change very quickly. So don’t wait. Sell at the market.

Second, if you haven’t done so already based on our guidance in our Safe Money Report and other publications, increase your allocation to gold bullion or equivalent.

The world’s largest gold bullion ETF — GLD — is still viable. Plus, you can purchase gold bullion coins from American Century, Dillon Gage, FideliTrade, Manfra, Tordella & Brookes, Rare Coins of New Hampshire, or other reputable dealers.

Third, substantially reduce your exposure to U.S. stocks, starting with the most vulnerable. For a reliable opinion on which those are,

• Sign up or sign in at www.weisswatchdog.com,

• Search for your stocks (using the first word of the name only),

• Add them to your Watchlist, and then

• Check your Watchlist to see the latest rating.

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Fourth, for vulnerable investments you do continue to hold, be sure to hedge. A handy vehicle: Inverse ETFs — ETFs designed to rise in value when your investments fall. Specifically,

• To hedge against a decline in U.S. Treasuries, you can use ProShares UltraShort Lehman 20+ Year Treasury ETF (symbol TBT), and …

• In addition to the inverse S&P ETF that I cited here last week, if you specifically want to hedge against a decline in U.S. financial stocks, consider ProShares Short Financials ETF (SEF).

Good luck and God bless!

Martin