Page 1 of 3 CREDIT BUBBLE BULLETIN Bankruptcy ahead
Commentary and weekly watch by Doug Noland
Q2 2009 Flow of Funds
Peter Eavis, writing in the Wall Street Journal on Friday, noted: "More than
half of US residential mortgages are being made by just three large banks. It
is a stunning change, but is it good for the housing market, and to what extent
will it boost profits over the long term for this elite trio: Wells Fargo, Bank
of America, and JP Morgan Chase? Right now, housing remains on government life
support. Treasury-backed entities are guaranteeing about 85% of new mortgages,
while the Fed buys 80% of the securities into
which these taxpayer-backed mortgages are packaged."
The Federal Reserve’s Z1 "flow of funds" report remains a "must read" when it
comes to grasping the happenings of the US credit system. Granted, the reams of
data may not be quite as captivating now as compared with the Wall Street
bubble years. But the report never disappoints.
For the quarter, non-financial credit growth accelerated to 4.9% annualized, up
from Q1's 4.1% and compared with Q2 2008's 3.3%. In nominal seasonally-adjusted
and annualized rate (SAAR) terms, non-financial debt expanded $1.646 trillion.
This was up strongly from Q1's $1.371 trillion SAAR, but still below the $2.0
trillion or so I deem necessary to (at least temporarily) stabilize the system.
Keep in mind that the economy remained quite weak for much of Q2. I would
expect Q3 credit growth in the neighborhood of $2.0 trillion annualized. For
perspective, non-financial credit expanded $865 billion in 2000, $1.152
trillion in 2001, $1.413 trillion in 2002, $1.671 trillion in 2003, $1.997
trillion in 2004, $2.329 trillion in 2005, $2.400 trillion in 2006, $2.539
trillion in 2007 and $1.888 trillion in 2008.
And while the recovery in credit is on the surface encouraging, the composition
of this growth is disconcerting. For the quarter, household debt contracted at
a 1.7% rate, with home mortgage and consumer debt down 1.4% and 6.5% annualized
- both worse than Q1 (declines of 0.1% and 3.7%). Corporate borrowings expanded
at only 1.0% annualized, down from Q1's 2.1% and compared to 6.7% back in Q2
2008. Private sector credit remains stuck in the muck.
Meanwhile, state and local debt growth accelerated to 8.3% annualized, up from
Q1's 4.9% and Q2 2008's 0.9%. State and local governments expanded borrowings
$187 billion SAAR - a resurgence back to the peak borrowing level from 2007
($186 billion). Federal borrowings expanded at a blistering 28.2% pace, up from
Q1's 22.6% and compared to Q2 2008's 5.9%. Federal borrowing increased to
$1.895 trillion SAAR during the quarter. State and local and federal combined
debt growth reached $2.082 trillion SAAR, significantly larger than the total
system non-financial debt growth of $1.646 trillion SAAR (with household credit
and mortgage debt contracting).
Over the past four quarters, non-financial credit expanded $1.959 trillion, or
6.1%, to $34.320 trillion. This was no small amount of debt growth. Treasury
borrowings increased $1.893 trillion over the past year to $7.143 trillion. And
during this period Federal Reserve assets ballooned $1.111 trillion, or 117%,
to $2.063 trillion. It is incredible to watch the emerging government finance
bubble take such command of US credit.
On an SAAR basis, the Federal Reserve increased agency and government-sponsored
enterprise-backed (GSE) securities $1.088 trillion during Q2 (nominal $272
billion). In nominal dollars, Fed holdings of agency (mostly mortgage-backed
securities, or MBS) increased from $20 billion at year-end to $559 billion by
the end of Q2. And keep in mind that home mortgage debt actually contracted $53
billion during this period (to $10.951 trillion).
There is a perception that the Fed's agency MBS purchase program is
specifically targeting stabilization of the conventional mortgage market. Yet,
examining the data, one can see that the private-label MBS marketplace is
perhaps the greater beneficiary of Federal Reserve largess. For the quarter,
issuers of asset-backed securities (chiefly pools of private-label/non-GSE
mortgages) contracted $499 billion SAAR, this after a $614 billion SAAR
contraction in Q1. But this was offset by an increase in GSE MBS of $556
billion SAAR in Q2 and $304 billion SAAR in Q1.
So, the Fed is amassing quite a stockpile of "conventional" GSE MBS, but often
these are "private-label" mortgages recently "refinanced" into GSE securities.
As the Fed buys the new GSE MBS, newly created funds become available to flow
back to reliquefy the formerly illiquid ABS marketplace (along with agencies,
Treasuries, corporates, and equities). To be sure, placing essentially federal
government backing upon previously "private-label" mortgages dramatically
changes the market's perception of these securities' worth ("moneyness") -
especially with fed funds pegged for an extended period at near zero and the
Fed in the midst of a $25 billion weekly purchase program in order to fulfill
it commitment to purchase $1.25 trillion of mortgage securities.
During the quarter, outstanding GSE MBS expanded at a 10.4% rate to $5.173
trillion. GSE MBS increased $414 billion, or 8.7%, over the past year and
$1.098 trillion, or 26.9%, over two years. During Q2, the ABS market contracted
at a 12.2% rate to $3.817 trillion. ABS declined $525 billion over the past
year, or 12.1%, and $673 billion, or 15%, over two years. Here we see
confirmation that nationalization of mortgage credit runs unabated. Not only is
the vast majority of new mortgage credit this year government-backed,
Washington guarantees are being slapped on hundreds of billions of existing
"nonconventional" mortgages. This intrusion and transfer of (credit and
interest rate) risk has terrible long-term ramifications, although in the
near-term this mechanism provides a powerful stabilizing force for both the
credit system and real economy.
Bank credit contracted at a 1.4% pace during the quarter to $9.523 trillion.
Similar to the money supply numbers, I have tended this year to deemphasize
private lending data in my analysis. After all, how much can we expect to
discern from traditional credit-related metrics when policymakers are issuing
trillions of Treasuries/agencies credit and the Fed is monetizing a trillion or
so?
It is, however, worth noting that bank holdings of government securities
expanded at a 16.2% pace during the quarter to $941 billion. Mortgages
increased at a respectable 4.6% clip to $3.899 trillion. Business loans
contracted at a notable 17.8% pace (to $2.031 trillion), although this may be
somewhat explained by the thawing of the corporate debt securities marketplace
(companies issuing debt to repay bank borrowings).
On the bank liability side, total deposits expanded at a 5.2% rate during the
quarter to $7.278 trillion (up 7.8% y-o-y). Credit market borrowings were about
flat at $1.720 trillion. Fed Funds and repo expanded ($133 billion) for the
first time in eight quarters (to $596 billion). Meanwhile, miscellaneous
liabilities contracted at a 24% rate to $2.468 trillion.
Posting the strongest growth since Q2 2007, securities broker/dealer assets
expanded at a 14.5% pace to $2.00 trillion. Broker dealer assets increased $514
billion SAAR during the quarter, although most of this is explained by an
increase in Treasuries holdings (up $404 billion SAAR). With the Fed's massive
MBS buying program in mind, it's not surprising to see broker/dealer holdings
of agency and MBS declining $179 billion SAAR.
It is worth noting that, on the liability side, security repos expanded $224
billion SAAR, the first increase in repos since Q1 2008. "Other" miscellaneous
liabilities increased $309 billion SAAR.
Examining the miscellaneous categories, finance companies contracted 8.6%
annualized to $1.777 trillion (down 7.9% y-o-y). Credit unions expanded 9.9%
annualized to $877 billion (up 9.1% y-o-y). Real estate investment trusts
increased 13.3% annualized to $260 billion (down 13.5% y-o-y). Money market
contracted at a 16.5% rate during Q2 to $3.584 trillion, cutting y-o-y growth
to 8.0%. Life insurance assets grew at an 11.9% pace to $4.552 trillion (down
6.6% y-o-y).
Rest-of-world holdings were down a rather insignificant $134 billion SAAR to
$14.200 trillion. There were, however, some meaningful changes in the
composition of foreign holdings of US assets. Net interbank assets contracted
$692 billion SAAR, while official Treasury holdings jumped $494 billion SAAR.
US corporate bond holdings declined $110 billion SAAR, while miscellaneous
assets expanded $227 billion SAAR.
In total, rest of world purchased $403 billion SAAR of Treasuries during Q2,
about a quarter of total issuance ($1.896 trillion SAAR). Who were the other
major purchasers? The Fed monetized $647 billion SAAR, the household sector
bought $343 billion SAAR, and broker/dealers accumulated $404 billion. And
while it is positive that American households are buying Treasuries and saving
more, this does not change the fact that this so called "savings" was bolstered
by income effects from massive government spending increases.
Examining income data, national income stabilized during the quarter at $12.162
trillion. After declining $347 billion annualized during Q4 2008 and $225
billion annualized during Q1, national income slipped only $47 billion
annualized during the quarter. National income was down 4.0% y-o-y. Total
compensation was down 3.8% y-o-y to $7.726 trillion. National income and
compensation began the decade at $8.358 trillion and $5.354 trillion. It is my
view that, at this point, only massive federal deficits and government
intrusions will stabilize system incomes at today's highly inflated levels.
Federal Q2 receipts were down 6.6% y-o-y to $2.215 trillion SAAR, while Federal
expenditures surged 35.9% to $3.510 trillion SAAR. For comparison, federal
expenditures were $2.393 trillion in 2004, $2.573 trillion in 2005, $2.728
trillion in 2006, $2.897 trillion in 2007 and $3.118 trillion in 2008. So
current spending levels are running almost 50% above where they were five years
ago. Second-quarter state and local receipts were just slightly ahead of the
year ago level to $2.004 trillion. Spending was slightly down from a year
earlier to $2.014 trillion.
The media was quick to pick up on the quarter's $2.0 trillion increase in
household net worth. For the bad news, net worth was still down $7.438 trillion
over the past year. With household liabilities essentially flat (down 1.0%
annualized) at about $14.10 trillion, changes in household assets dictate the
increase/decrease in net worth.
For the quarter, assets were up $1.964 trillion, or 12.0%, to $67.208 trillion.
This jump places asset values back to mid-2005 levels. Real estate holdings
actually rose $157 billion (nominal) to $20.026 trillion, the first increase in
10 quarters. Yet, reflation's real impact was felt in the $1.777 trillion
(17.5%) jump in household holdings of Financial Assets. Over the past year, the
value of real estate declined $1.759 trillion and financial assets dropped
$6.043 trillion. It is worth noting that, despite the crisis, household net
worth was up about a third in seven years.
To summarize, there were no surprises in the Q2 2009 Flow of Funds. What I saw
was confirmation of the government finance bubble thesis. "Uncle Sam Bets the
House on Mortgages" was the headline for an insightful article in the Wall
Street Journal on Friday (Peter Eavis). It would as well make a good title for
recent Z1 Flow of Funds reports.
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