Egan-Jones, the first ratings firm to signal doom for Enron, WorldCom and Lehman Bros., has such a dire outlook for Spain and Italy that policymakers can only hope this time is different.
Or else, they can take what Egan-Jones sees as the only viable path: major debt restructuring.
The current track for Spain and Italy is a deep, unending recession and debt spiral, in the view of the small, independent credit ratings agency.
While eurozone optimists expect the current recession to give way to growth in mid-2013, Egan-Jones projects that GDP will contract at least 4% a year through 2014 in both Spain and Italy.
At that point, Spain's debt (including contingent liabilities) is projected to hit 146% of GDP, up from 83.5% at the end of 2011.
Italian sovereign debt is seen hitting 165% of GDP from 132.3% in 2011 (including contingent liabilities).
Nobody Wants A Haircut
"We don't see them recovering without a significant haircut on their outstanding debt," Sean Egan, president of the Haverford, Pa., firm, told IBD in an interview.
With a restructuring that eases the weight of debt on the economy and removes the risk of a euro exit, there's no reason growth can't resume, Egan says.
But "nobody wants to take haircuts," says Egan-Jones senior analyst Bill Hassiepen. Instead the aim has been to "cure leverage with even more leverage.
In the past two weeks, Egan-Jones has cut its ratings for Spain and Italy further into junk territory. Standard & Poor's, Moody's and Fitch still give investment grades to both countries.
Unlike its bigger, better-known rivals, who are compensated for their ratings by the issuing company or country, Egan-Jones is paid only by institutional investors interested in an opinion free from any conflict of interest.
A study co-authored by Stanford University business professor William Beaver after the WorldCom and Enron debacles found that Egan-Jones bond ratings changes were "timelier" and captured "more of the information that the stock market deems important to the valuation of securities.
The study also found that Moody's "lacks the incentive to be responsive" because of its well-entrenched market position.
Egan-Jones proved its worth in corporate bonds. While it's still creating a sovereign track record, its April 30 move to cut Spain's to junk now looks prescient. Spain's 10-year yield was at 5.75% on its way to 7.5% last week.
Still Kicking The Can
Since European Central Bank President Mario Draghi threw down the gauntlet last Thursday, essentially vowing to eliminate risk of a sovereign default, Spain's 10-year yield has retreated to about 6.6%.
Egan and Hassiepen don't dismiss the possibility that Draghi will be able to kick the can down the road one last time.
Using ECB leverage to boost the eurozone bailout fund's 500-billion-euro capacity for buying distressed sovereign debt would "delay part of the crisis but increase the ultimate pain," Egan said.
One shortcoming is that it would increase Germany's exposure to losses, "putting downward pressure on its rating," Egan said.
Hassiepen calls it "a mathematical impossibility" for Germany to bail out the rest of the eurozone.
If the ECB were to signal that it will print as much as necessary to avoid debt restructuring, Hassiepen said that would send a message that it's ready to monetize the debt, inflating away its value.
"I doubt very seriously that would attract investors outside of the EU because I think they would see it in a minute."
