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3 CREDIT BUBBLE
BULLETIN Q3 2012 Flow of
Funds Commentary and weekly
watch by Doug Noland
In further proof
that I don't pander to readers, I'll dive into the
Federal Reserve's Q3 2012 "Flow of Funds" data.
For the quarter, the growth in total
non-financial debt (TNFD) slowed to a rate of
2.4%, less than half the 5.1% pace from Q2 2012,
but close to the 2.5% rate from Q3 2011. After
expanding at a 10.9% rate in Q2, federal debt
growth slowed sharply to 6.2%.
State & local borrowings
about flat-lined (negative 0.1%), a marked
slowdown from Q2's 3.1% rate of expansion.
Interestingly, after expanding at a 1.2%
rate in Q2 (strongest since Q1 '08), total
household debt contracted 2.0% annualized during
Q3. Home mortgage debt contracted at a 3.0% rate
(vs. Q2's 2.1% contraction), while non-mortgage
household debt growth slowed to 4.3% (from Q2's
6.5%, the strongest since Q3 2007's 7.6%).
Corporate debt expanded at a robust 6.2% pace
during Q3, little changed from Q2 (6.3%).
In seasonally adjusted and annualized
rates (SAAR), total non-financial debt (TNFD)
growth slowed to $952 billion, down from Q2's
$1.971 trillion. This places average growth for
the first 9 months of the year at SAAR $1.564
trillion, which compares to 2011's $1.325
trillion, 2010's $1.438 trillion, 2009's $1.059
trillion, and 2008's $1.891 trillion. Keep in mind
that annual trillion FD growth was in the
neighborhood of $650 billion back in the
mid-nineties. In the first nine months of 2012,
total non-financial debt expanded a nominal
(non-annualized) $1.163 trillion.
By
sector, federal borrowings increased $825 billion
(71% of total) in nine months, total business $374
billion (32%), state & local $18 billion (2%),
and total household negative $58 billion (negative
5%). The federal government's unprecedented
dominance of system credit is now well into its
fifth year.
I'm going to somewhat cut to
the chase and jump to the household balance sheet.
Typically, a sharp deceleration in credit growth
would be associated with general credit market
weakness. And early in Q3 there was some
Europe-related market stress and modest financial
conditions tightening. This was, however, met with
overwhelming policy measures in Europe ("whatever
it takes"), with the Fed ("QE infinity") and
elsewhere. The end result was a period of
significantly loosened finance, higher asset
prices and, importantly, a policy-induced
inflation in household net worth.
For the
quarter, household sector assets jumped $1.711
trillion to $78.204 trillion. Over the past year,
household assets have inflated $6.073 trillion, or
fully 39% of GDP, to now having almost recovered
back to late-2007 record highs. And with household
liabilities contracting slightly to $13.436
trillion, household net worth gained $1.722
trillion during the quarter to a record $64.769
trillion. Household net worth was up $6.103
trillion, or 10.4%, over the past year and $10.084
trillion, or 18.4%, over two years.
To
explain the strength in retail sales over the past
couple years, one need not venture much beyond the
extraordinary $10 trillion increase in perceived
household net worth. It is also worth noting that
82% of this gain can be explained by the rise in
household holdings of financial assets.
The profound role fiscal and monetary
stimulus has had on bolstering incomes, spending,
corporate earnings and asset prices is fundamental
to the "government finance bubble" thesis. Total
national income expanded at a 3.9% pace during the
quarter to a record SAAR $13.912 trillion. Total
compensation increased at a 3.0% pace to a record
SAAR $8.568 trillion, with total comp up $250
billion over the previous year, or 3.0%. Over two
years, total compensation jumped $546 billion, or
6.8%. For comparison, total comp expanded about
$820 billion during the booming two-year period
2005-2006.
Driving the two-year inflation
in household net worth and Incomes was a $2.463
trillion jump in federal liabilities, to a record
$13.111 trillion. Federal liabilities inflated
23.1% in two years, with a 17-quarter increase of
$6.614 trillion, or 96%. Outstanding Treasury debt
was up $1.153 trillion over the past year (11.4%),
$2.262 trillion over two-years (25.1%), and $6.005
trillion over 17 quarters (114.4%).
Federal debt-to-GDP increased to 83%, yet
this of course excludes most of our government's
massive contingent liabilities. A Wall Street
Journal op-ed from last week (Chris Cox and Bill
Archer) noted "actual liabilities of the federal
government - including Social Security, Medicare,
and federal employees' retirement benefits -
already exceed $86.8 trillion, or 550% of GDP".
At SAAR $3.757 trillion, federal
government expenditures were up 0.4% from Q3 2011,
and federal receipts were 6.8% higher to SAAR
$2.683 trillion. Going back five years (to Q3
2007), federal expenditures have inflated $847
billion, or 29%, while receipts have gained only
$18 billion, or 1%.
Credit bubbles are at
their core about an unsustainable expansion of
credit - the inflation of financial claims spurred
by market misperceptions and associated
mispricing. During the bubble, the rapid expansion
of credit is self-reinforcing specifically because
financial profligacy will ensure that most
"fundamentals" (ie corporate profits, GDP, stock
prices, etc) appear supportive. And, importantly,
major credit bubbles are invariably created
through heightened government intervention in
"money", the markets and throughout the real
economy.
The perception that Treasury,
congress and the Fed would never tolerate a
housing bust was the critical fallacy that ensured
a historic boom and bust cycle. In somewhat
different dynamics than those of the mortgage
finance Bubble period, extraordinary fiscal and
monetary measures have convinced the marketplace
that the historic confluence of massive issuance
of (non-productive government) debt and record
high debt security prices is both sensible and
sustainable.
Once again, market price
distortions are driven by the perception of
all-powerful intervention, in this case that the
Federal Reserve and foreign central banks will
indefinitely accumulate this debt at record high
prices.
For Q3 2012, rest of world (ROW)
accumulated US financial assets at SAAR $625
billion to a record $19.388 trillion. In what
would not appear a great vote of confidence,
demand was predominantly for low-yielding
government debt. Treasury holdings expanded SAAR
$624 billion (to $5.445 trillion).
Agency-GSE-backed securities increased SAAR $21
billion ($1.067 trillion), while corporate bonds
declined SAAR $4 billion ($2.444 trillion) and
loans to corporate business fell SAAR $29 billion
($164 billion).
Holdings of US equities
increased SAAR $186 billion ($3.471 trillion),
mutual fund shares increased SAAR $44 billion
($646 billion) and foreign direct investment grew
SAAR $86 billion ($2.998 trillion). Other
miscellaneous assets dropped SAAR $354 billion
($1.539 trillion).
The foreign
accumulation of our nation's financial assets has
been integral to sustaining the great credit
bubble. Foreign holdings of US financial assets
began the '90s at about $1.9 trillion before
ending the decade at $5.776 trillion. Balances
swelled incredibly during the mortgage and
government finance bubbles.
ROW holdings
more than doubled between 2002 and 2007, expanding
$8.673 trillion during the mortgage bubble period
to end 2007 at $16.038 trillion. ROW holdings
dropped almost $800 billion during 2008 and
expanded only $567 billion in 2009. Net annual
purchases then swelled to $1.599 trillion in 2010
and $1.396 trillion in 2011. Markets today retain
faith that foreign central banks and others will
maintain their insatiable appetite for US
financial claims - no matter the quantity or
quality of issuance.
Treasury and US
fixed-income prices have certainly been inflated
by the perception of a Federal Reserve market
backstop. While the Fed's balance sheet contracted
$46 billion during the quarter to $2.838 trillion,
asset growth has returned during Q4 - and the Fed
is apparently determined to commence another
aggressive balance sheet inflation cycle beginning
in January (talk of $85 billion monthly
purchases).
Perhaps the sharp Q3 slowdown
in system credit expansion contributed to the
latest bout of acute dovishness afflicting our
central bankers. Maybe they examined recent
mortgage debt trends and fretted, "How on earth
can we ever orchestrate a handoff of the credit
baton from the public sector back to the private
sector if mortgage credit is not expanding! Yields
must be pushed lower still!"
It is worth
noting that the Fed's balance sheet closed out the
nineties at $697 billion, and then ended 2004 at
$841 billion, 2006 at $908 billion, 2007 at $951
billion, 2008 at $2.271 trillion, 2009 at $2.267
trillion, 2010 at $2.453 trillion and 2011 at
$2.947 trillion. 2013 $3.5 trillion? I couldn't
suppress a chuckle after reading a Friday
Bloomberg headline: "Ballooning Balance Sheet
Brings Fed Closer to Exit-Plan Overhaul". Well,
that's one way of looking at it.
I've
essentially ignored the (stagnant) banking system
in my "flow of funds" analyses over recent
quarters. Total bank assets grew only $66 billion
during Q3 to $14.762 trillion - and were up only
$197 billion (1.4%) over the past year. Yet I
would be remiss for not noting the 9.7% y-o-y
increase in business loans (to $2.174 trillion) or
the 8.3% y-o-y increase in government securities
holdings (to $2.231 trillion).
Meanwhile,
corporate bond holdings were down 4.1% y-o-y (to
$776 billion), mortgage loans contracted 2.0% (to
$4.334 trillion) and misc. Assets fell 11.0% y-o-y
(to $1.267 trillion). On the bank liability side,
total deposits were up $495 billion, or 4.9%,
y-o-y to $10.532 trillion.
With federal
government liabilities now locked in an historic
inflationary cycle, there's at this point a
significantly reduced need for the traditional
workings of the US financial sector. The vast
majority of system credit growth remains
governmental. In stark contrast to the mortgage
finance bubble, this credit for the most part need
not be intermediated (transformed from risky
credit to perceived safe instruments) through the
banking system, or through asset-backed (ABS) and
mortgage-backed (MBS) securitization.
It
is also worth noting that, at $7.544 trillion,
total GSE securities (debt and MBS) were little
changed during the quarter and declined only 0.5%
over the past year. And while total home mortgage
credit has contracted $660 billion over the past
two years, GSE securities have declined only $54
billion. Despite talk of "winding down" Fannie and
Freddie, total GSE securities are about where they
were in early 2008. It is worth noting that GSE
securities began year-2000 at $1.723 trillion.
Monitoring the financial sector for signs
of rejuvenation remains less than fruitful.
Finance companies were stagnant for the quarter
and year. Securities broker/dealer assets were
down slightly during the quarter (assets up $70
billion, or 3.5% y-o-y, to $2.051 trillion). The
ABS market continues to contract (down $216
billion y-o-y to $1.824 trillion). Money Market
Funds expanded $39 billion during the quarter to
$2.507 trillion, reducing the year-over-year
contraction to $170 billion. Fed Funds and Repo
increased $32 billion y-o-y, or 2.9%, to $1.134
trillion. Funding corps increased $70 billion
y-o-y, or 3.6%, to $2.256 trillion. Credit union
assets did see year-over-year growth of 5.5% to
$897 billion. Real estate investment trust (REITs)
liabilities jumped $67 billion to $792 billion,
with one-year growth of $172 billion, or 28%.
From my analytical perspective, the SAAR
$299 billion contraction of home mortgage credit
was the biggest surprise for the quarter. This
compares to Q2's $214 billion contraction and Q3
2011's $200 billion decline. With mortgage
borrowing costs having taken another leg down to
historic lows - and all the talk of an unfolding
housing recovery - I was anticipating a return to
positive mortgage credit growth in Q3 or Q4.
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