Page 1 of 3 CREDIT BUBBLE BULLETIN
Off the scales
Commentary and weekly watch by Doug Noland
Bloomberg's Mark Pittman and Bob Ivrya reported last Tuesday: " ... the US
government has pledged more than US$11.6 trillion on behalf of American
taxpayers over the past 19 months, according to data compiled by Bloomberg.
Changes from the previous table, published February 9, include a $787 billion
economic stimulus package. The Federal Reserve has new lending commitments
totaling $1.8 trillion. It expanded the Term Asset-Backed Lending Facility, or
TALF, by $800 billion to $1 trillion and announced a $1 trillion Public-Private
Investment Fund to buy troubled assets from banks. The US Treasury also added
$200 billion to its support commitment for Fannie Mae and Freddie Mac ... "
The administration's new budget projects an astounding $1.75 trillion fiscal
2009 federal deficit - or about 12% of GDP. Federal
outlays are expected to surge 32% this year to $3.94 trillion. In nominal
terms, the deficit is set to quadruple the previous all-time record. In
percentage terms one has to return back to the war economy of the 1940s to find
anything comparable.
On Thursday, Fannie Mae reported a fourth-quarter loss of $25.2 billion,
bringing the company's second-half 2008 shortfall to more than $50 billion.
Non-performing assets surged a stunning 87% during the quarter to $119.2
billion, a three-fold increase in just 12 months. Having more than depleted its
razor-thin capital base, Fannie requested $15.2 billion of additional Treasury
support (from the $200 billion promised).
The Federal Deposit Insurance Corporation (FDIC) announced on February 26 a
$26.2 billion fourth-quarter 2008 loss for the banking system. The Office of
Thrift Supervision reported that the country's savings & loans lost $3.0
billion during the final quarter of the year, increasing 2008 losses to a
record $13.4 billion. General Motors announced a $9.6 billion fourth-quarter
loss, increasing its annual loss to a staggering $30.9 billion. Analysts are
expecting even greater losses to be reported at AIG and Citigroup.
The dimensions of the reported deficits and losses are not easily digested; the
scope of the present systemic problems are not so easily comprehended. I'll
push ahead with efforts to use the credit bubble framework as an analytical
tool for making some sense of the historic nature of the unfolding bust.
Let's try to place the various huge and increasingly numbing deficit/loss
numbers (attendant with this bust) into coherent context. For such an endeavor
it is imperative first to examine the preceding boom. This week, in particular,
seems an appropriate time to summarize, in credit terms, the incredible
dimensions of the fateful inflationary bubble.
From the Federal Reserve's "flow of funds" report, we can see that total system
credit (non-financial and financial) ended 1995 at $18.475 trillion. By the end
of 2007, this number had inflated to $49.882 trillion, for growth of 170% in
only 12 years. During this period, household debt swelled 184% to $8.959
trillion; non-farm corporate debt 130% to $3.832 trillion; and state and local
government borrowings 109% to $2.192 trillion. Federal debt expanded "only" 41%
to $5.122 trillion. Rest-of-world holdings of US assets inflated 365% to
$16.048 trillion. While significantly trailing credit growth, gross domestic
product nonetheless bulged 87% during this period.
Over the past decade, the "optimists" often cited the federal government's
positive fiscal position as evidence of the health of the overall economy and
soundness of our prosperity. It should be clear these days that the protracted
boom's massive inflation of private-sector credit had grossly inflated
government receipts (among other things). Indeed, over the 12-year period
federal receipts inflated 88% (to $2.651 trillion) and state and local receipts
increased 92% (to $1.903 billion). This crucial facet of the inflationary boom
spurred federal and state and local spending growth of 80% and 93%,
respectively.
State and local governments will now attempt to maintain these inflated levels
of expenditures, while the federal government will move aggressively to grossly
inflate already inflated spending. The budget now calls for federal
expenditures this year to approach $4.0 trillion. This compares with spending
of about $1.6 trillion back in 1995. The federal deficit is projected to expand
by a combined $3.0 trillion during fiscal years '09 and '10. This would amount
to a 60% increase in federal debt in only two years.
Today's unparalleled expansion of federal debt and obligations is being dressed
up as textbook "Keynesian". It's rather obvious that we are in dire need of
some new books, curricula and economic doctrines. But from a political
perspective, the title is appropriate enough. From an analytical framework
perspective such policymaking is more accurately labeled "inflationism" - a
desperate attempt to prop inflated asset prices, incomes, business revenues,
government receipts, and economic "output". There have been many comparable
sordid episodes throughout history, and I am not aware of any positive
outcomes.
The administration's budget earmarks an additional $750 billion as a
contingency for added financial sector bailouts. Fed data nicely illuminate the
dimensions of the financial sector's problem. Between 1996 and 2007, total
mortgage debt expanded 220% to $10.061 trillion. Total GSE agency securities
(debt and MBS) tripled to $7.397 trillion. The ABS market inflated 580% to
$4.50 trillion. Over this 12-year period, bank assets swelled 150% to $11.194
trillion. Securities broker/dealer assets ballooned 440% to $3.10 trillion.
In 12 years, total financial sector borrowings expanded 300% to $16.90 trillion
- in the process creating a credit and liquidity junky out of US asset markets
and the real economy. Today, the deeply impaired financial sector is incapable
of assuaging the system's bloated credit needs.
For perspective, a little compare and contrast is in order. Total mortgage debt
increased $188 billion in 1995, compared with $1.437 trillion growth in 2005,
$1.410 trillion in 2006, and $1.098 trillion in 2007. Agency MBS increased $98
billion in 1995, compared to $609 billion growth last year. The ABS market grew
$127 billion in 1995, in contrast to the $725 billion growth in 2005 and 2006's
$808 billion. Bank credit expanded $273 billion in 1995, compared to 2007's
$788 billion and 2008's $1.294 trillion. Broker/dealer assets expanded $113
billion in 1995, against 2007's fateful $615 billion growth.
This unprecedented credit explosion inflated asset prices as well as incomes.
Between 1996 and 2007, national incomes inflated 90% to $12.271 trillion.
Compensation of employees surged 86% to $7.812 trillion. Bubble impacts were
even more dramatic with respect to the household (including non-profits)
balance sheet. In 12 short years, household sector asset holdings inflated
$43.685 trillion, or 133%, to $76.549 trillion. Despite household liabilities
surging 185% to $14.379 trillion, household net worth (assets minus
liabilities) inflated $34.360 trillion, or 124%, to $62.170 trillion.
Importantly, this massive inflation of perceived financial wealth over years
glossly distorted the quantity and pattern of spending throughout the real
economy.
This historic credit-induced inflation of household incomes and net worth was
at the core of deep structural maladjustment to the US "bubble" economy. The
implosion of "Wall Street finance" (in particular the collapse of broker/dealer
financing, private-label MBS and other ABS, and various methods of leveraging
mortgage, corporate and other securities) marked the demise of various bubbles,
including ones in private-sector debt securities, residential and commercial
real estate, equities, and household net worth more generally.
In the final analysis, the bust has left multi-trillion dollar holes in various
sector balance sheets. Moreover, patterns of spending throughout the economy
have been forever altered. Year-after-year of reckless lending has quickly come
home to roost in a big way.
Our federal government has commenced the process of attempting to fill holes
through the massive inflation of government credit and obligations (by the
trillions). Depending on the reader's perspective, I risk appearing either the
master of the obvious or a rabid sensationalist. Yet the stakes associated with
the current course of fiscal and monetary policy are absolutely momentous. And
I am compelled to write that "if you're not confused you don't understand the
nature of the problem".
What are the ramifications and consequences associated with US deficits
approaching 12% of GDP? Over the short and intermediate terms? Will
unprecedented fiscal and monetary measures stem financial sector implosion?
Will Washington's efforts work to bolster a faltering bubble economy, or will
they instead only tend to delay unavoidable structural adjustment? Will the
Treasury market continue to so easily accommodate reflationary efforts? How
long will the dollar remain relatively stable in the face of massive growth in
US non-productive credit? Will multi-trillions of government debt and
obligation expansion help to resuscitate private-sector credit creation - or
will it instead simply destroy the creditworthiness of the entire economy?
Not uncharacteristically, I pose more questions than I have answers. But I do
fear that we now face trillion-dollar deficits as far as the eye can see. I
don't expect "Keynesian" policies to have much success in reinvigorating busted
asset markets. I'll be surprised if private-sector credit creation bounces back
any time soon. I fear policymaking will do more harm than good when it comes to
needed economic restructuring.
And my worst fears of policymaking (fiscal and monetary, Democrat and
Republican, national and local) bankrupting the country are being anything but
allayed. Similar to my belief that mortgage credit growth should have been
limited to, say, no more than 4% or 5% annually during the boom, there is today
a very serious need to incorporate some reasonable limits on the expansion of
federal debt and obligations.
WEEKLY WATCH
For the week, the Dow dropped 4.1% (down 19.5% y-t-d), and the S&P500 fell
4.5% (down 18.6%). The Transports were hit for 7.4% (down 29.3%) and the Morgan
Stanley Cyclicals 6.0% (down 30.3%). The Morgan Stanley Consumer index declined
5.8% (down 17.3%), and the Utilities lost 3.5% (down 12.6%). The S&P400
Mid-Cap index dropped 3.7% (down 16.5%), and the small cap Russell 2000
declined 5.3% (down 22.1%). the Nasdaq100 sank 4.8% (down 7.8%), and the Morgan
Stanley High Tech index dipped 2.2% (down 6.3%). The Semiconductors gained 1.2%
(down 5.9%), while the InteractiveWeek Internet index slipped 0.7% (down 1.0%).
The Biotechs were hammered for 9.5% (down 7.8%). The Broker/Dealers dropped
4.5% (down 16.8%), while the Banks rallied 11.3% (down 45.5%). With Bullion
down $48, the HUI Gold index sank 9.8% (down 4.2%).
One-month Treasury bill rates ended the week at 16 bps, and three-month bills
were at 26 bps. Two-year government yields were unchanged at 0.92%. Supply
worries had five-year T-note yields ending the week up 12 bps to 1.92%.
Ten-year yields surged 23 bps to 3.02%. Long-bond yields rose 15 bps to a
3-month high 3.77%. The implied yield on 3-month December '09 Eurodollars
increased 7 bps to 1.53%. Benchmark Fannie MBS yields jumped 20 bps to 4.45%
(high since 12/09). The spread between benchmark MBS and 10-year T-notes
narrowed 3 to 143 bps. Agency 10-yr debt spreads narrowed 2 to 61 bps. The
2-year dollar swap spread increased 3.25 to 69 bps; the 10-year dollar swap
spread increased 6.25 to 31.5bps, and the 30-year swap spread increased 6.25 to
negative 24.5 bps. Corporate bond spreads were wider. An index of investment
grade bond spreads widened 9 to 244 bps, and an index of junk spreads widened
26 to 1,233 bps.
It was another week of strong corporate debt issuance. Investment grade
issuance included Chevron $5.0 billion, JPMorganChase $4.8 billion, Hewlett
Packard $2.75 billion, PepsiCo $1.0 billion, Noble Energy $1.0 billion, Waste
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