U.S. subprime mess spreads to Europe -- Reallocate

August 1, 2007

The subprime mortgage mess that wreaked havoc on the U.S. economy has spread across the Atlantic. IKB, a small German bank, filed a report with the SEC on Monday stating its total exposure to subprime loans is €8.1 billion (around $$11 billion). IKB said, as a result, it will significantly miss earnings for the year, causing its CEO to resign. KfW, the government-owned development bank, said it will cover IKB's losses to prevent the crisis from spreading. The German government owns 38% of IKB.

Commerzbank, Germany's second largest bank, also reported that it will face €80 million in losses from defaults on U.S. subprime mortgages. Share prices fell nearly 3% on the news. (Source: Financial Times, Subprime woes hit German banks, 7/31/07; International Herald Tribune, IKB's exposure to U.S. subprime crisis, 7/31/07)

What the subprime mortgage spread to Europe means:
First, it was thought that the U.S. subprime mortgage mess was confined to the U.S. housing market. Then, it spread to the U.S. economy and now to European banks. 

The risk is that foreign banks will now tighten credit standards, as U.S. banks have done, further limiting liquidity. This, combined with current higher interest rates, could slow the European economy.

The greater risk is if fear of further losses grip the global stock markets, causing a greater sell-off than we saw last week. As fear and greed grip the markets, this will add to volatility.

Action steps:

Check with your financial planner about reallocating funds. Now may be a good time to move out of small cap, since small companies are dependent on low interest rates and liquidity to grow. It might also be a good time to underweight finance companies, in case the subprime mortgage mess continues its spread throughout the globe.

Related Articles:

Private equity firms, 5/30/07

China invests $3B in U.S. company, 5/23/07

Gold hedges against the stock market, 4/11/07

Global risks shifting to you, 3/28/07

Global stock markets decline, 3/7/07

The growth of hedge funds, 6/10/06

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