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5 CREDIT-BUBBLE
BULLETIN What is left that is
sellable? Commentary and weekly
watch by Doug Noland
The release of the
Federal Reserve Board's Flow of Funds data for the
fourth quarter and full-year 2007 underscores the
continuing bursting of numerous economic bubbles,
with no end in sight. The root of the problem, of
course, can be traced to faltering real estate
finance. As the year ended, even the booming
commercial mortgage sector slowed markedly and we
can safely forecast that numbers there will fall
off a cliff in this quarter.
When it comes
to credit bubble analysis, the Rest of World (ROW)
page in the Fed’s Z.1 "Flow of Funds" report is
actually the one I contemplated the most (and with
the greatest unease) last week. ROW increased
holdings of US financial assets by $1.573 trillion
last year, or 11.4%. With the bursting of the
credit bubble and the resulting impairment of US
securities, such growth
has
become unsustainable. ROW holdings of US financial
assets were up an astounding $7.222 trillion, or
88%, in just four years.
ROW more than
doubled holdings of agency/GSE MBS ($1.379
trillion) and almost doubled corporate bonds/ABS
($2.583 trillion) position since the beginning of
2004. Security repo holdings grew from $460
billion to $1.100 trillion. US equities almost
doubled (94%) to $2.806 trillion. Total credit
market instrument positions were up 79% over four
years to $6.855 trillion.
During the
fourth quarter alone, ROW holdings of US credit
market instruments expanded at an SAAR $1.045
trillion. Interestingly - and a much less than
"bullish" dynamic - the composition of assets
acquired changed markedly. Treasury and agency
purchases accounted for 62% of purchases, up from
about 15% during Q3. And with the international
banking community now in full retreat away from US
structured finance and risk assets, the ROW’s
stalwart increase in US "Misc Assets" and
corporate bonds is surely in serious jeopardy.
Today, with Treasury yields having
collapsed, agency securities having lost their
luster, and even investment grade corporates
heavily tarnished, it is not at all clear as to
which US financial assets today hold sufficient
appeal to our foreign creditors. It is anything
but obvious as to how we will now sustain a smooth
"recycling" of our massive current account
deficits. And I certainly don’t believe it is any
coincidence that the recent alarming widening in
agency debt and MBS risk premiums has occurred
concurrently with the acceleration in dollar
weakness.
I will continue to examine the
stark contrasts between the current post-bubble
"reflation" attempt and those that preceded it.
When the seemingly irrepressible bubble in Wall
Street finance was inflating, aggressive Federal
Reserve rate cuts fed quickly into speculative
leveraging; heightened demand for securitizations;
aggressive lending in the asset markets; asset
inflation; and the inflation (of volume and
prices) of myriad credit instruments with
perceived limited liquidity and credit risk
(certainly including ABS, MBS and agency debt,
along with more sophisticated Wall Street debt
instruments and structures).
The Fed
didn’t really need to concern itself with the
dollar. Not only were foreign financial
institutions rushing in to play the boom in US
"structured finance", the US credit system was
creating perceived "money"-like securities that
were the envy of the world. As fast as our trade
deficits and speculative outflows flooded the
world with dollar liquidity, this finance would
return to find a perceived "safe and secure" home
through various monetary processes right back into
our asset-based securitization markets. It was a
bubble of historic proportions and it’s all laid
out on the L.107 page in the Fed’s Z.1 report.
We haven’t heard much of the "Bretton
Woods II" nonsense lately. Somehow, everyone
wanted to make believe that we would always enjoy
the luxury of trading endless new securities for
imported energy, commodities, capital equipment,
cheap electronics, and all the consumer goods we
could ever dream of. The problem was that our
credit system was issuing ever larger quantities
of increasingly suspect financial claims (well
documented in the Fed’s "Flow of Funds").
Well, the entire world has become aware of
our situation and will be less than keen to
accumulate more of our debt. The Fed’s willingness
to cut rates so drastically in the midst of
faltering confidence and heightened inflationary
pressures is certainly exacerbating the very
dangerous dislocation that has erupted in the
agency, MBS and investment-grade corporate
markets.
For the year, total credit
(non-financial and financial) expanded a record
$3.998 trillion (8.9%) to $48.808 trillion. This
was a moderate increase from 2006’s growth of
$3.859 trillion (9.4%), and compares to 2005’s
$3.310 trillion, 2004’s $3.178 trillion, 2003’s
$2.779 trillion, 2002’s $2.781 trillion, 2001’s
$2.020 trillion, and 2000’s $1.679 trillion. Total
credit market debt averaged $2.500 trillion annual
growth over the 10-year period 1997 to 2006.
Non-financial credit increased $2.351 trillion
(8.1%) in 2007, compared with the previous year’s
$2.334 trillion. Financial credit surged $1.569
trillion (11.1%), up from 2006’s $1.273 trillion
(9.9%) and 2005’s $1.015 trillion (8.5%). It is
worth noting that financial sector credit growth
averaged about $500 billion annually during the
nineties.
In true bubble blow-off fashion,
total corporate debt expanded at a 12% annualized
rate during the fourth quarter, with 2007's growth
of 11.6% the strongest since 1998. Now that bubble
has burst as well. We’re now poised for a year of
significantly slower debt growth - a serious
dilemma for both the highly over-leveraged
financial sector and the deeply maladjusted US
bubble economy. The negative effects to the real
economy from a lack of credit are becoming
increasingly evident.
Bursting credit
bubble dynamics were certainly discernible in
fourth-quarter data. Financial sector debt growth
slowed sharply from Q3’s 15.7% rate to a somewhat
more moderate 9.0%. The previously hot
asset-backed securities (ABS) sector hit the wall,
contracting at a seasonally-adjusted and
annualized rate (SAAR) of $282 billion - for
perhaps the first ever quarter of negative ABS
growth. Recall that ABS expanded a record $773
billion during 2006 (24%).
And the
securities broker/dealers contracted SAAR $701
billion during Q4, after expanding a record $615
billion (28.9%) during 2006. REITs posted negative
growth for the quarter, as did finance companies.
In the real economy, total compensation expanded
at a 4.1% rate during Q4, down notably from Q3’s
6.3%, Q2’s 6.2%, Q1’s 6.0%, and Q4 ‘06’s 6.5%. The
interplay between weakening credit dynamics and
income growth will be of major consequence this
year and going forward.
Total mortgage
debt (TMD) growth slowed to SAAR $864 billion
during Q4 (5.9% rate), down sharply from Q3’s SAAR
$1.050 trillion (7.7%) and Q2’s SAAR $1.208
trillion (9.2%). Home mortgage debt growth slowed
to a 4.5% annual pace, down from Q3’s 6.5% and
Q2’s 7.9%. The commercial mortgage sector slowed
to 9.3%, down from Q3’s 11.2% and Q2’s 15.0%.
For all of 2007, total mortgage debt
growth slowed to $1.057 trillion (7.8%), down from
2006’s $1.404 (11.6%), 2005’s $1.432 trillion
(13.4%), 2004’s $1.270 trillion (13.5%), 2003’s
$996 billion (11.9%), 2002’s $905 billion (12.1%),
2001’s $708 billion (10.4%), and 2000’s $561
billion (9.0%). Total mortgage debt averaged $268
billion annually during the nineties. I’ll throw
out a guess of less than $500 billion for 2008, a
number greatly insufficient to sustain still
inflated home values. And while home prices
captivate the media, an abrupt shut down in
commercial mortgage credit is in the process of a
rather problematic bursting of commercial real
estate price bubbles as well.
Bank
mortgage loans actually expanded at a 13.5% rate
(SAAR $510 billion) during the quarter to $3.633
trillion. Total bank credit expanded at a 13.8%
rate (SAAR $1.270 trillion) during Q4 to $9.163
trillion. Along with mortgages, commercial loans
expanded at a 23.6% pace to $2.012 trillion (SAAR
$474 billion). The asset security credit jumped
SAAR $108 billion, and corporate & foreign
bonds rose SAAR $225 billion. Treasury securities
increased SAAR $48 billion, while agency and GSE
securities contracted SAAR $225 billion.
Whether by choice or, more likely,
necessity, the banking sector significantly
increased its risk asset holdings at an
inopportune time. For the year, bank credit
expanded a record $992 billion, or 9.7%, the
strongest pace of expansion in 10 years.
With the market for "private-label"
mortgage securities dislocating (see ABS
analysis), the GSEs were left to take up the
slack. Agency mortgage-backed securities expanded
SAAR $784 billion to $4.443 trillion, a record
showing. The fourth quarter's 18.8% expansion
increased 2007 agency MBS growth to 15.8%, double
the pace from 2006. In fact, last year's $606
billion increase in agency MBS was approaching
double the previous record increase ($338 billion)
set back in 2001.
Meanwhile, GSE assets
(as opposed to MBS guarantees) expanded at a 12.9%
rate during the quarter to $3.183 trillion. For
the year, GSE assets expanded $310 billion
(10.8%), up significantly from 2006’s $56 billion
(1.9%) to the largest expansion since 2001 ($344
billion). Federal Home Loan Bank System (FHLB)
advances jumped by more than a third last year to
$873 billion. Total agency securities (debt and
MBS) issuance surged to SAAR $1.128 trillion
during Q4, with 2007's $888 billion issuance
almost three times the volume from 2006 ($331
billion) and more than 10 times 2005 ($83
billion). It was not a good time for the highly
leveraged and exposed GSEs to significantly
increase their risk profiles.
The ABS
bubble came to an abrupt conclusion during Q4.
After expanding at a 24.4% pace during Q4 2006,
growth slowed to 10.6% during Q1, 12.1% in Q2,
0.9% in Q3 and then a contraction of 6.1% during
Q4. For the year, ABS growth slowed markedly to
4.4% ($177 billion), ending the year with
outstandings of $4.221 trillion.
Last
year's growth was down sharply from 2006’s 23.6%
($773 billion) growth, 2005’s 25.8% ($671
billion), and 2004’s 19.6% ($426 billion).
Importantly, the ("Wall Street-backed") ABS market
ballooned $2.47 trillion in four years, or 94%.
This historic issuance of fundamentally weak
credits - at the finale of a prolonged credit
bubble - will haunt our system for years to come.
Securities broker/dealer assets contracted
SAAR $701 billion during the quarter to $3.095
trillion. This reduced 2007 growth to $354
billion, or 12.9%. This was down from 2006’s
record $615 billion (28.9%) expansion.
Broker/dealer assets ballooned 132%
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