(MoneyWatch) While attention is diverted to the escalating U.S. sex scandal, guess which country is back in the news? Greece is making headlines again and unfortunately, the news is not good. Many investors expected that the indebted country would receive the next $40 billion loan installment this week, but eurozone finance ministers failed to agree on releasing the funds and will take up the decision next Tuesday.
Greece raised the money it needed to avoid default on an upcoming bond repayment, but investors are getting nervous. I know what you are thinking: I'm just trying to pay my mortgage, do I really need to worry about all of this noise in Greece and Europe? Yes, because the fate of the U.S. economic recovery and your 401(k) may hang in the balance.
It's not surprising that the five most beleaguered eurozone countries -- Italy, Spain Portugal, Greece and Cyprus -- are already mired in deep recessions. But the entire 17 country region saw GDP shrink by 0.3 percent in the second quarter and the European Union's executive commission predicts it will shrink 0.4 percent this year. In other words, the eurozone as a whole is in recession too. The ECB expects the region to grow by only 0.1 percent all of next year.
The eurozone recession is already being felt across the globe, and the world's big exporters are taking the biggest hits. The Chinese economy, which counts Europe as its largest trading partner, has seen growth slow to 7.4 percent; Japan is on the verge of recession, if not already there; India's economy is growing at its slowest pace in nearly a decade; and Russia's Q3 GDP expanded at its slowest rate in more than two years. These problems have hit home: The global pullback has hammered U.S. manufacturing, which slowed to a crawl over the summer and has seen job creation stall as a result.
The other big concern with Europe is that it could gum up the world's financial system. When weaker countries have to pay more to borrow money, the banks that had previously loaned money to weaker countries lose money on those earlier loans. Rising borrowing costs for weaker euro zone countries, combined with European bank losses, could cause a larger financial meltdown.
While U.S. banks have reduced exposure to the European banking system, a failure of the global financial system would cause immediate negative repercussions. At the precise moment when credit is becoming easier, a European banking crisis would make it harder to get a loan for a house, a car or a small business. There would also likely be a major stock market meltdown that would be reminiscent of the bad old days of 2008-2009.
Maybe European officials will get their acts together and resolve the three-year, slow-motion financial crisis. But given their track record it's hard to be overly-optimistic. For those who didn't see the 2008-2009 meltdown until it was too late, the good news is that this version is in plain sight, which means you can plan ahead to protect yourself. Here are 10 things to do right now to prepare for a potential eurozone melt-down.
1. Try to build 6 to 12 months of living expenses in an emergency reserve fund at an FDIC-insured financial institution. I know that's easier said than done, but nothing is sweeter than a cash cushion when the world is in disarray. For those who have jobs that could be at risk in another downturn or a recession, it's advisable to err on the side of being more conservative. Remember, it takes an average of nearly 40 weeks to land a new job. If you have a big expense coming up in the next year (tuition, car purchase), make sure that the money is set aside in addition to your emergency reserve fund.
2. Stay below FDIC limits. At the depths of the financial crisis, Federal Deposit insurance increased to $250,000 and has remained there since. If you have more than $250,000 in a financial institution, you should open a new account at another FDIC-insured institution or insured credit union. While U.S. banks are in far better shape than they were in 2008-2009, why assume the risk of your money disappearing due to a bank failure?
3. Check your money market fund. Remember when the net asset value of shares in the Reserve Primary Money Fund fell below $1, primarily due to losses on Lehman Brothers commercial paper? Well, maybe your friendly brokerage firm has a few nasty loans to a large European bank that could cause a similar drop in value. If you are stashing a large amount of money in a money market fund, you might want to transfer that cash in a federally insured bank or credit union instead.
4. Lock-in a loan now. If the eurozone implodes, U.S. banks are likely to freeze up, which means it will be even harder to get a loan for a house, a car or a small business. If you are in the market to refinance or about to secure a car loan, get the loan closed sooner than later.
5. Establish a line of credit. If you don't have an adequate emergency reserve fund, but do have equity in your home, it may make sense to establish a line of credit now, while banks are still lending.
6. Check loan covenants. In 2008-09, many small business were shocked when banks closed off access to loans and lines of credit. Better to know now what powers the banks have and to plan accordingly.
7. Diversify all investment accounts. Of course you meant to re-balance and diversify your investment accounts, but you just never got around to it. With Europe hanging by a thread and stock investors seemingly oblivious to the huge downside risk, get busy! The benefit of diversifying now is that you can avoid making a rash decision in the midst of a downturn. Remember that from 2000-2009, a diversified portfolio of stocks and bonds BEAT a riskier portfolio of 100 percent stocks.
8. Don't sell everything! Just because Europe could drag down the economy and the markets, doesn't mean that it will. Don't fall prey to your emotions and go to cash because doing so requires that you time the market perfectly not once, but twice: when you sell and then when you decide to buy back in. Too many investors sold in panic at the worst levels of the 2008-2009 crisis have never gotten back in. as a result, they have missed the massive stock market recovery that has seen stocks almost double from the lows. It's hard, but investors must guard against fear and greed--they are powerful emotions!
9. Considering selling company stock. Maybe your company matches your 401k contribution in company stock or provides stock grants as an employee incentive. If the position is more than 5 - 10 percent of your total portfolio value, you might want to sell. If Europe melts down, investors will likely sell everything, including your company stock. There's no need to assume the risk of owning an individual stock in good times or bad.
10. Review your financial plan. When you developed your plan, what were your expectations for rates of investment return? If Europe drags down the global economy, the total return in the next five years could be lower than what your plan anticipated.