Page 1 of 3 CREDIT BUBBLE BULLETIN Q1's flow of funds Commentary and weekly watch by Doug Noland
Total Domestic Non-Financial Debt (NFD) expanded at a 4.1% seasonally-adjusted
and annualized rate (SAAR) during the first quarter. This was down from Q4
2008's 6.2% and was below Q1 2008's 5.4%. Total system credit (non-financial
and financial) increased $371.8bn, or 2.8% annualized, to a record $52.904 TN -
and was up $2.238 TN over the past year, or 4.4%. Talk of "credit collapse" has
been overdone.
During the first quarter, total Household Sector debt contracted at a 1.1%
rate, with household mortgage borrowings unchanged during the quarter. Flat
household mortgage debt growth compares to Q4's negative 1.7%, Q3's negative
2.4%, and Q2's negative 0.3%. Home mortgage borrowings declined 1.6% over
the past year. Total mortgage debt was down only $67.2bn y-o-y, or 0.5%. Total
Business Borrowings declined at a 0.3% rate during the quarter, although
Corporate debt expanded at a 2.0% pace during the quarter. Total Business
borrowings were up 3.2% over the past year.
Rapidly expanding government debt more than offset the small first quarter
declines in Household and Business borrowings. State & Local debt expanded
at a 4.9% rate - a notable bounce back from Q4's 0.4% contraction and the
strongest growth since Q4 2007. Yet most of the credit for Q1's respectable NFD
growth goes to our federal government, where borrowings surged at a 22.6%
annualized pace.
Treasury debt outstanding increased a nominal $466bn during the quarter to
$6.804 TN. Over the past year, Treasury debt expanded an unprecedented $1.505
TN, or 28.4%. But Washington's giant credit footprint is not confined to the
Treasury issuance boom. GSE borrowings expanded SAAR $259bn during the quarter
to a record $3.452 TN. In %age terms, GSE debt expanded at a 7.6% rate during
the quarter and was up 7.2% y-o-y. Agency MBS growth was even stronger,
expanding SAAR $300bn during Q1 to surpass $5.0 TN ($5.052 TN) for the first
time. Agency MBS expanded at a 6.5% rate during the quarter and was up 9.6%
from a year earlier. During the past eight quarters, the GSEs have expanded
19.5% and agency MBS 27.5% - a massive and ongoing nationalization of mortgage
credit and interest-rate risk.
First quarter combined Treasury, GSE debt, and agency MBS growth surged to SAAR
$2.0 TN. In nominal dollars, total combined Treasury, GSE and MBS expanded
$612bn during the quarter, or 16.7% annualized, to $15.298 TN. These "federal"
debt obligations ballooned an alarming $2.177 TN over the past year, or 16.6%.
This was just below 100% of one-year total system credit growth, highlighting
the most conspicuous aspect of an expanding government finance bubble.
Analyzing the financial sector these days is fraught with challenges. I feel
for the staff at the Federal Reserve responsible for aggregating the data. And
despite my years of dissecting the "flow of funds," this quarter's financial
sector data has me stumped. Examining the "L" (level) pages, Total Financial
Sector credit market borrowings contracted a meager $72bn to $17.015 TN (up
3.7% y-o-y). Yet the "F" (flows) pages show a huge (SAAR $1.792 TN) decline for
financial sector borrowings during the quarter. The "level" page has bank
Financial Assets up almost $500bn during the quarter (almost $700bn increase in
Misc. Assets), while the "flow" page has bank assets contracting. Hopefully
we'll have more clarity with Q2 data and revisions.
Securities Broker/Dealer Assets contracted a nominal $305bn during the quarter
to $1.913 TN, bringing the one-year drop to $1.332 TN (although some of this
has moved to bank and Federal Reserve balance sheets). And Open Market Paper
(CP) fell $175bn during the quarter to $1.424 TN, with a one-year decline of
$361bn (20.2%). And Fed Funds & Repo contracted $201bn during Q1 to $1.055
TN, with a notable one-year drop of $1.086 TN (50.7%). Federal Reserve assets
declined $149bn during the quarter to $2.122 TN, although assets were up $1.190
TN, or 128%, over the past year.
So with recent bank credit stagnation and contractions experienced by the Wall
Street firms, the commercial paper market, and the Fed - some analysts see
support for the credit collapse viewpoint. But this ignores the massive ongoing
issuance of Treasuries, GSE debt and agency MBS - not to mention a more recent
booms in corporate and muni debt issuance. Again, keep in mind that
Non-financial debt did expand at a 4.1% rate during the quarter, a pace of
credit expansion that I expect is being exceeded during the current quarter.
National Income declined a modest $48bn (annualized) during the first quarter
to a $12.255 TN pace. This was a slower contraction than Q4's $189bn
(annualized), with National Income declining 1.6% y-o-y. Total Compensation was
up 0.2% y-o-y to $8.024 TN. From my analytical perspective, the massive -
almost $2.2 TN - "federal" credit boom has for now stabilized system-wide
Compensation and Income. Yet the sustainability and consequences of the
Government Finance bubble create - at best - great uncertainty. I'll stick with
the analysis that two Trillion-plus of government credit creation is necessary
to hold bubble Economy implosion at bay - and that this amount of
Washington-based finance comes with its own set of serious issues (including
exacerbating global financial and economic distortions).
It is a primary theme of current credit bubble analysis that the unfolding
Government Finance bubble-driven global reflation will be of an altogether
different nature than previous Fed/Wall Street-induced reflations. For one, the
major reflationary monetary mechanism has shifted from Wall Street finance
(securities firms' balance sheets and securitizations, "repo" finance, hedge
funds, etc. - to various avenues of government finance. As such, we are
expecting a lasting shift in the flow of finance away from the asset markets,
with important ramifications for household wealth and spending. The Flow of
Funds provides confirmation of this analysis.
Household Balance Sheet data make for dreadful analysis. Despite incredible
government stimulus, Household sector Assets declined a further $1.444 Trillion
during the quarter. This brought the one-year drop to an unrivaled $10.075
Trillion (13.5%). At $64.517 TN, Household Assets have returned to year-end
2005 levels. Over the past year, Financial Assets declined $7.869 TN (16.3%) to
$40.296 TN and Real Estate dropped $2.279 TN (10.3%) to $19.819 TN. Household
Liabilities contracted at a 3.2% rate during the quarter to $14.141 TN, with a
one-year drop of 2.1% ($301bn). As such, Household Net Worth contracted $1.330
TN, or at a 10.3% rate, during Q1 to $50.376 TN. Household Net Worth dropped
$9.774 TN over the past four quarters, or 16.2%, deflating back to about the Q3
2005 level.
There are also indications of potential trouble from Rest of World (ROW) flow
analysis. ROW holdings declined for Agency/GSE-backed securities, Open Market
Paper, US Time Deposits, Inter-bank Assets, Corporate Bonds, and Loans to
Corporate Business. Meanwhile, Treasury holdings expanded SAAR $636bn during
the quarter to $3.341 TN. Our foreign creditors may be content to recycle
dollar flows back into Treasuries, but they are thus far in no mood to return
to financing our business or household sectors. This may prove a major factor
contributing to an altered flow of finance throughout the US economy. It can
also be read as a warning that the crucial process of dollar recycling rests
increasingly on market perceptions of the soundness of one single market - US
Treasuries.
Financial reform received keen focus this week. Everyone agrees the previous
regulatory framework failed profoundly in restraining excesses throughout
mortgage and Wall Street finance. So I would like to know which regulator in
the new regime is going to protect the system from similar excesses throughout
government finance. Same problem as before: No one will step up and reign in a
bubble. There's always an excuse - masterful justifications and
rationalizations. And, of course, the intellectual frameworks operating in
Washington and elsewhere would adamantly insist that now is the absolute worst
time to reign in government borrowing.
So disciplining Washington will be left to the marketplace. On the one hand,
the markets were content to accommodate Wall Street's self-destruction for far
too long. On the other, the markets were burned and would seemly now be heedful
of "Ponzi Finance" dynamics.
WEEKLY WATCH
For the week, the S&P500 dropped 2.6% (up 2.0% y-t-d), and the Dow fell
2.9% (down 2.7% y-t-d). The Banks lost 3.4% (down 15.8%), and the
Broker/Dealers were hit for 5.0% (up 26.8%). Economically-sensitive stocks were
under pressure. The Morgan Stanley Cyclicals sank 6.2% (up 16.4%), and the
Transports fell 4.2% (down 9.0%). The Morgan Stanley Consumer index slipped
only 1.4% (up 1.5%), and the Utilities dipped 1.4% (down 6.5%). The broader
market pulled back. The S&P 400 Mid-Caps dropped 3.1% (up 7.4%), and the
small cap Russell 2000 lost 2.7% (up 2.7%). The Nasdaq100 declined 1.3% (up
21.4%), and the Morgan Stanley High Tech index fell 2.4% (up 32.3%). The
Semiconductors dropped 3.8% (up 24.7%), and the InteractiveWeek Internet index
fell 3.5% (up 40.0%). The Biotechs were down only 0.6% (up 4.9%). With Bullion
down about $4.0, the HUI gold index fell 2.8% (up 12.4%).
One-month Treasury bill rates ended the week at 11 bps, and three-month bills
closed at 18 bps. Two-year government yields declined 7 bps to 1.19%. Five-year
T-note yields were little changed at 2.78%. Ten-year yields declined 2 bps to
3.78%. The long-bond saw yields end the week down 14 bps to 4.50%. The implied
yield on 3-month December '09 Eurodollars declined 4.5 bps to 1.055%. Benchmark
Fannie MBS yields were down 12 bps
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
