Europe starts to feel the subprime pinch

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On Tuesday, the European Commission published its economic growth estimates for the euro zone. Not surprisingly, a slowdown is expected. The commission downgraded growth estimates for 2007 from 2.6 percent to 2.5 percent in the 13 countries that use the euro, while growth rates for the rest of the EU were lowered from 2.9 percent to 2.8 percent. 

Predictably, the commission blamed the slowdown on the meltdown of the subprime mortgage market in the United States. According to the report:

It is clearly too early to quantify the possible impact [of the subprime crash] on the global economy.However, the turmoil has clearly tilted the balance of risks to the downside.

EU Economic and Monetary Affairs Commission Joaquín Almunia urged calm, insisting underlying fundamentals are strong enough to sustain the European economy in a tighter credit environment. 

It’s true that solid fundamentals may be able to sustain the global economy in the short term. What isn’t clear is whether they’re strong enough to float the economy through the duration of the subprime crash. Most subprime loans have adjustable interest rates, which increase after three years. These kinds of loans became popular in 2004 at the start of the housing boom and remained popular until the spring of this year, when interest rates on these loans adjusted higher. When this happened, people couldn’t make their payments and foreclosures spiked. So we can expect continued increases in the number of foreclosures until about 2010. This has already caused many home lenders in the United States to close. Now, Northern Rock, one of the UK’s largest lenders is in need of emergency funding to stay afloat. 

Whether this means the global economy is headed for recession or a few years of flat growth is still unclear. However, it’s highly doubtful that the fundamentals to which Almunia referred are alone strong enough to sustain the delicate EU economy for the next three years.