Page 1 of 3 CREDIT BUBBLE BULLETIN Q4 'Flow of Funds'
Commentary and weekly watch by Doug Noland
The Federal Reserve's latest "Flow of Funds", or Z.1, report, covering the
fourth quarter of 2009, carries few surprises. For all of 2009, US
non-financial debt (NFD) expanded 3.3%, down from 2008's 5.9%. In nominal
dollars, NFD expanded $1.116 trillion, the smallest expansion since 2000 ($865
billion). There has been much discussion about the ongoing credit contraction.
For the year, household home mortgage debt contracted $165 billion, consumer
credit contracted $113 billion, and total business borrowings contracted $200
billion.
I have tried to highlight the massive counterbalancing inflation of "federal"
credit. Federal government (Treasury) credit expanded a record $1.444 trillion
last year (two-year gain of $2.683 trillion) and
government-sponsored enterprise (GSE) mortgage-backed securities (MBS) grew
$422 billion (a two-year gain of $920 billion).
In the domestic financial sector, borrowings fell an unprecedented $1.753
trillion for the year. Bank credit declined $467 billion, GSE assets dropped
$371 billion, and the asset-backed securities (ABS) market shrank $675 billion.
At the same time, the Fed's holdings of agency and GSE-backed securities
ballooned $979 billion.
It was another extraordinary year in credit and financial flow analysis. There
are numerous complexities that make this a challenging endeavor. There were
gigantic charge-offs (banks and GSEs) that reduced outstanding mortgage and
consumer debt. Near-zero interest rates also worked to reduce the amount of
financial sector debt expansion created in the process of paying interest on
outstanding liabilities (ie deposit liabilities increasing as interest is
accrued to depositor accounts).
It is also difficult to ascertain the various credit impacts from the Fed's
$1.0 trillion monetization of MBS. Many factors make it difficult to gauge the
true scope and nature of the credit creation flowing to the real economy. It's
my view that the $1.1 trillion net increase of NFD likely understates the real
expansion of system credit/purchasing power for 2009.
I have asserted that the monetary and fiscal policy response to the 2008
bursting of the Wall Street/mortgage finance bubble fostered the emergence of
the global government finance bubble. Over the past six quarters, Treasury debt
has jumped $2.531 trillion, or 48%, to $7.782 trillion. During the same period,
federally backed GSE-MBS expanded $624 billion, or 13%, to $5.383 trillion.
Combined "federal" finance ballooned an incredible $3.155 trillion in just 18
months. At the same time, the Federal Reserve's balance sheet jumped $1.315
trillion, or 138%, to $2.267 trillion.
Unprecedented policy responses sent a clear message: the securities markets are
too big to fail. Sure, the massive fiscal stimulus mobilized purchasing power
throughout the economy. And, yes, the trillion monetized by the Ben Bernanke
Federal Reserve unleashed a wall of liquidity upon the markets. Yet there's
another critically important facet of system stabilization: the historic
collapse of risk premiums - especially in mortgage and corporate debt - can be
at least partially explained by the market's perception that Washington will
respond to future crises with the Powell Doctrine of overwhelming fiscal and
monetary force.
The market today perceives that essentially no amount of stimulus or
monetization is out of bounds. The Fed is there as a backstop bid for debt
securities, while the Treasury and Federal Reserve have teamed to establish a
floor under gross domestic product / national income. Market malformations now
lie at the heart of the unfolding bubble and go a long way toward explaining
the market's complacency when it comes to the simultaneous contraction in
private-sector credit and the explosion of federal debt and obligations.
During Q4, total system credit (TSC) declined $132 billion to $52.417 trillion.
TSC has declined for three consecutive quarters. Yet it has still increased 52%
during the past six years, increasing from just over 300% of GDP to over 360%
today. Over the past six years, non-financial credit has inflated 57% and
financial sector credit has gained 42%.
Total mortgage debt (TMD) declined 2.1% during 2009 to $14.307 trillion. TMD is
flat over two years but is still up 72% over seven years. TMD contracted at a
3.2% rate during Q4, the same pace as Q3. Household mortgage borrowings
contracted at a 2.1% rate during Q4 (to $10.786 trillion), an improvement from
Q3's 3.4%. Commercial mortgage borrowings contracted at a 7.4% pace (to $2.486
trillion), accelerating from Q3's 4.0% pace of decline.
The ABS market contracted another $186 billion during Q4 to $3.394 trillion.
ABS was down $702 billion, or 17.1%, for the year. Much of this decline is
explained by the ongoing contraction in "private-label" MBS. There have been
huge write-downs in this space. Yet there's an ever bigger factor. Low interest
rates and myriad government programs have encouraged millions of borrowers to
replace their old mortgages with new ones enjoying government (Fannie Mae,
Freddie Mac and Federal Housing Authority) guarantees and much lower yields.
Placing a government stamp on hundreds of billions of mortgages has been a
major stabilizing force.
Lower debt-service costs were not the only factor bolstering household
consumption. Importantly, household assets rose $657 billion during Q4 to
$68.188 trillion. For the year, assets jumped $2.579 trillion - recovering a
chunk of 2008's $13.226 trillion drop. Household liabilities contracted $26
billion during Q4 and were down $194 billion for the year (1.4%) to $14.0
trillion. Accordingly, household net worth gained $682 billion during Q4 to
$54.176 trillion. For the year, net worth jumped $2.772 trillion. Net worth has
now returned to 2005 levels. For the year, household real estate holdings were
down $905 billion (to $18.207 trillion), while financial assets were up $3.407
trillion (to $45.115 trillion).
National Income posted strong Q4 gains ($152 billion). For the year, national
income was down only $22 billion, or 0.2%, to $12.412 trillion. Total
compensation declined slightly ($17 billion) during Q4 to $7.735 trillion. For
the year, total comp was down $296 billion, or 3.7%. There is no doubt that
massive fiscal stimulus was instrumental in stabilizing system incomes at,
arguably, rather inflated levels. National income ended 2009 51% above where it
began the decade, with total compensation 44% higher.
Q4 federal expenditures were up 15.1% y-o-y to an annualized $3.595 trillion.
Expenditures jumped to $3.466 trillion for all of 2009. For comparison,
expenditures were $2.573 trillion in 2005, $2.728 trillion in 2006, $2.897
trillion in 2007 and $3.118 trillion in 2008. Q4 federal receipts were down
8.8% y-o-y to $2.232 trillion annualized. For the year, receipts were down 10%.
State and local government Q4 borrowings expanded at a 4.7% rate, up from Q4
2008's 0.2% but down from Q3 2009's 5.5%. For all of 2009, state and local
government debt expanded 4.8%, up from 2008's 2.5%. Q4 state and local receipts
were up 3.5% y-o-y, while expenditures gained 1.0%.
Returning to the financial sector, bank assets were little changed for the
quarter at $14.137 trillion. For the year, assets were up $136.3 billion, or 1%
(largely explained by the acquisition of broker/dealer assets). Bank credit, on
the other hand, was down $371 billion year on year to $9.301 trillion. Down
only 0.7% during Q4, bank credit stabilized going into year end. For the year,
bank holdings of government securities jumped 15.6% to $1.462 trillion. Bank
mortgage loans were little changed for the year at $3.819 trillion.
Miscellaneous bank assets were up $417 billion, or 12.1%, for the year to
$3.868 trillion. On the bank liability side, deposits were up $466 billion year
on year to $7.642 trillion.
Rest of world (ROW) holdings of US assets jumped $290 billion last year to
$15.423 trillion. ROW is up $3.90 trillion over four years (despite 2008's $960
billion decline). For 2009, total Treasury holdings jumped $503 billion to
$3.713 trillion. Agency holdings dropped $130 billion year on year to $1.315
trillion. Corporate bond holdings declined $100 billion to $2.357 trillion.
Securities broker/dealer assets expanded slightly during Q4 to $2.080 trillion
(down 6.2% year on year). Finance company assets contracted at a 9.9% rate
during the quarter to $1.691 trillion (down 8.7% year on year). Credit Unions
expanded 5.9% annualized during Q4 to $885 billion (up 8.9% year on year).
REITs declined 5.9% (down 27% y-o-y). Life insurance company assets expanded
5.7% annualized to $4.819 trillion (up 6.7% y-o-y). Money market funds
contracted $104 billion during Q4 (to $3.59 trillion), with a 2009 decline of
$499 billion.
There were few surprises in the Z.1 report. The gains in household net worth
and national income do help explain the decent recovery in consumption. The
ongoing expansion of Treasury, GSE MBS and Federal Reserve credit supports the
government finance bubble thesis.
As we look forward to 2010 data, I would expect a meaningful uptick in the rate
of system credit expansion. It is my view that, in a more normal rate/liquidity
environment, it will take in the neighborhood of $2.0 trillion of system credit
growth to sustain our current economic structure. I expect that - until the
debt markets say otherwise - the majority of this will be "federal" credit.
WEEKLY WATCH
For the week, the S&P500 gained 1.0% (up 3.1% y-t-d), and the Dow added
0.6% (up 1.9% y-t-d). The Banks surged 3.8% (up 18.1%), while the
Broker/Dealers increased 1.1% (up 3.3%). The S&P500 Regional Bank index
jumped 5.5%, increasing y-t-d gains to 24.1%. The Morgan Stanley Cyclicals
added 1.3% (up 5.7%), and the Transports jumped 3.1% (up 5.5%). The Morgan
Stanley Consumer index increased 0.8% (up 3.6%), while the Utilities slipped
0.6% (down 5.1%). The Morgan Stanley Retail index rose 2.3%, increasing 2010
gains to 12.6%. The S&P Supercomposite Restaurant index jumped 4.0% this
week, boosting y-t-d gains to 8.5%. The broader market posted another solid
week. The S&P 400 Mid-Caps gained 1.7% (up 7.9%), and the small cap Russell
2000 rose 1.6% (up 8.2%). The Nasdaq100 gained 1.9% (up 3.4%), and the Morgan
Stanley High Tech index increased 2.2% (up 2.5%). The Semiconductors increased
1.1% (down 1.3%). The InteractiveWeek Internet index jumped 2.8% (up 5.0%). The
Biotechs rose another 4.7%, increasing 2010 gains to 30.3%. With bullion down
$32, the HUI gold index dropped 2.9% (down 3.1%).
One-month Treasury bill rates ended the week at 9 bps, and three-month bills
closed at 14 bps. Two-year government yields rose 6 bps to 0.88%. Five-year
T-note yields increased 8 bps to 2.34%. Ten-year yields gained 2 bps to 3.70%.
Long bond yields slipped 2 bps to 4.63%. Benchmark Fannie MBS yields rose 2 bps
to 4.34%. The spread between 10-year Treasury and benchmark MBS yields was
little changed at 64 bps. Agency 10-yr debt spreads narrowed one to 35 bps. The
implied yield on December 2010 eurodollar futures gained 2.5 bps to 0.90%. The
10-year dollar swap spread was little changed at 4.75, while the 30-year swap
spread increased 1.75 to negative 15. Corporate bond spreads were narrower. An
index of investment grade bond spreads narrowed 3 to 82 bps, and an index of
junk spreads narrowed 14 to 522 bps.
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