US Subprime Issues Affect Asian Growth

Implications: The reduction in US consumer spending is hopelessly enmeshed in the availability of mortgage credit, housing prices, and generalized consumer confidence.  The slowdown in the US economy, tied to these three macro forces, will greatly affect both established and emerging markets across the globe.  No where will this be more felt than in Asia.

Analysis: Goldman's forecast relates to three general conditions.  Recession (both standalone in the US as well as in concert with Japan); emerging markets; and currency weakness.  The general result of these conditions is clearly diminshed growth rates in Asia.

Where are these recessionary economics coming from, and why are matters getting worse?

While the clearest effect of the subprime debacle is its effect on housing prices in markets across the US, one cannot underestimate the effect of lessened refinance activity on spending.  Correlated is the generalized consumer mindset.  The trend is affecting both the affuent and the average individual in the US.  This too is not due to simple macroeconomic principle, but rather to the availability of mortgage credit.

What is at the very heart of the subprime meltdown is the overextension of credit beyond reasonable loan to value limitations.  Seeing the opportunity to earn fee income by continuing to refinance existing mortgage debt, subprime lenders catered (perhaps even solicited) troubled borrowers whose focus was on spending.  Individuals were driven to reduce their monthly debt obligations, but rather than retire their revolving lines of credit, they would pay them down using the proceeds of the refinance activity, and then immediately continue the pattern of spending that would build balances quickly.

The largest effect on consumption rates is being driven by some borrowers (primarily the subprime credit risk) who cannot obtain additional funds or recast their current loans with additional cash out, as well as the "prime" or "Alt-A" customer who cannot refinance because their loan to value ratio is not acceptable given that their property has depreciated.  These individuals and households were dependent on revolving credit to pay for their spending.  With out the possibility to eliminate monthly obligations through cash out refinance, a much greater portion of their net pay must go to debt service.  Consumers are "cash poor" and thus confidence is lacking, and they are afraid to make both large and small purchases at the consistent growth rate for spending evidenced over the past few years.

Clearly the effects on Asia are significant.  The articles comments about India and China also address that outsourcing is becoming more costly in emerging markets, in part because of currency appreciation.  A vicious circle where the lack of consumer confidence and spending in the US further increases difficulty with imports and related growth.   All the worst though for India, as many of the firms closest to the mortgage lending industry are the biggest utilizers of outsourced programming, IT enabled services, and call center services.  As these firms consolidate, there is a smaller pool of potential customers, while diminished volumes have a very large effect on per transaction services or even hourly rates for offshore operations.