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Cramer: What a Second Lehman Could Look Like

Should Greece default on its debt, some fear Europe will implode. It will create an Armageddon-like scenario that many suspect will be similar to the collapse of Lehman Brothers.

For his part, Cramer said Thursday he doesn't think that will happen. He thinks France and Germany will work with the International Monetary Fund to avoid another Lehman-type situation. But the "Mad Money" host wanted to use an up day to discuss just what the "Chicken Littles" are fearing. In other words, he discussed what the worst case scenario would look like, even though he doesn't think it will happen.

First, Greece defaults and everyone stops buying bonds around Europe, including those from Ireland, Portugal and Spain. In turn, those countries default, too. Like Latin America in the 1980s, huge amounts of debt are cancelled and re-issued in the form of bonds nobody wants.

Second, the hit takes out foreign banks and we learn they had insured the government paper and the bank paper went under. It would be the European equivalent of Lehman, Bear Stearns, AIG and the like. These banks are closed or merged by the surviving countries' financial institutions. It could also be that they are nationalized outright with all common stock, preferred and corporate bonds wiped out, though the customers' accounts are preserved.

Third, huge layoffs sweep Europe and the Continent is thrown into another recession because so many banks are made insolvent by the insurance contracts they offered to struggling governments.

Fourth, Europe's recession pulls down the USA because of the tie-ins and because two or three U.S. banks had hidden exposure to Europe. The U.S. learns about the exposure too late because there still is not enough transparency and U.S. banks are still buying and insuring un-insurable risk over there. These banks are merged with healthy banks that have raised a lot of capital, but the stocks get hammered to their 2008 and 2009 lows.

Fifth, massive layoffs strike the U.S. because of Europe. The U.S. economy wasn't growing anyway, though, and the country is sinking under the weight of higher commodity prices, Washington dithering and a president, who has failed to create jobs. As the U.S. continues to sink, commodity prices plummet and construction stops due to weak demand. The industrials take a beating every day.

Sixth, money flows from risky assets to high-yielding companies that weren't' high-yielders all that long ago. Safety stocks rally because commodities collapse and margins widen. This move happens on the way down, even as corporations were prepared for the downturn. The cyclicals don't get much love, though, and fall to their 2008 and 2009 levels, as well.

Seventh, new defensive plays emerge. These stocks do well because they don't need growth. Food stocks will also do well because commodity prices have been crushed.

Eighth, because commodities have collapsed, China stops tightening and wage inflation ends. That stems the decline in industrials that have been pummeled because of fears of Chinese tightenings. These stocks can be bought with 4 percent yields.

Ninth, companies fall back to cash levels. People think that their earnings are going to collapse because of the recession. These companies can now be bought with 5 percent yields.

Tenth, the U.S. employment rate skyrockets past 10 percent. People leave the market in droves and stocks go to price-to-earnings multiples of 10 or lower. But being as the earnings aren't there, the multiples are really about 15 or so.

All said and done, it adds up to a near 63 percent pullback of the entire 6,000 point run in the Dow. The average could touch the 7,500 level, where there would be bargains galore, even though nobody would want them.

So if this plays out, Cramer noted it wouldn't be as bad as 2009. But it would be bad. Still Cramer's not buying into any of this. He actually thinks we're closer to a bottom than we are to a top.

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