Federal Reserve Q3 2003 Z.1 “flow of funds” report.
While it does require some thinking back, the third quarter was an extraordinary period for the Credit system in several respects. The period demonstrated exceptional growth; it marked the end of an historic mortgage refi boom; and there was near dislocation within interest rate markets as yields spiked higher and some key spreads and volatilities blew out to the widest levels since LTCM (it today seems like such a long time ago). There was a major shifting of assets (and liabilities) by players caught in the interest rate tumult. There was also a marked deceleration and near stagnation of money supply growth, and with it renewed talk of faltering liquidity, deflation and even a collapse in Credit. With this in mind, I was especially excited by yesterday’s (delayed) arrival of the Fed’s quarterly Z.1 report.
First of all, there was certainly no indication of any meaningful slowdown in the historic Credit Bubble. Total Credit Market Debt (Non-financial and Financial) increased at an 8.6% annualized rate during the third quarter to $33.6 Trillion. Over the past year, Total Credit Market Debt increased $2.784 Trillion, or 9.0%. For comparison, Total Credit Market Debt increased $2.22 Trillion during 2002, $1.877 Trillion during 2001 and $1.792 Trillion during 2000. Since the beginning of 1998 (23 quarters), Total Credit Market Debt is up a whopping 59% ($12.4 Trillion!).
Non-financial Borrowings (NFB) increased at a 7.4% rate to $22.0 Trillion. Over four quarters, NFB has expanded $1.736 Trillion, or 8.6%. By sector, Federal Government Debt expanded at an 8.2% rate to $3.95 Trillion, with a 12-month rise of 10.3%. Total Household Debt increased at an 11.2% rate during the quarter to $9.18 Trillion, with a 12-month rise of 11.2%. State & Local Governments increased debt at a 10.5% rate during the quarter to $1.542 Trillion, with a 12-month rise of 10.5%.
Lagging, Total Corporate Debt increased at a 3.4% rate during the quarter to $7.33 Trillion, with a 12-month rise of 4.2%. It is worth noting that when the government and household sectors are borrowing so aggressively, one would expect resulting strong cash-flows (profits) to lessen corporate borrowing requirements.
It is one of many curious facets of contemporary economic doctrine that Financial Sector borrowings are deemed basically irrelevant; non-financial debt creation is paramount and to examine Financial Sector debt amounts to mindless “double counting.” But to ignore financial sector liability creation and asset accumulation is to disregard one of the key aspects of contemporary finance and the Great Credit Bubble.
I strongly argue that financial sector expansion (including foreign institutions’ dollar asset accumulations) is the key liquidity-creating mechanism in today’s financial markets. It is surely much more useful to focus on financial sector liabilities generally, rather than to fixate exclusively on “bank money” or the money supply aggregates. In fact, in this environment the analysis of the expansion of a broad range of financial sector liabilities is fundamental for avoiding some rather major blunders. With this in mind, Financial Sector Borrowings increased at a near record annualized $1.178 Trillion, or 10.9%, to $11.09 Trillion during the third quarter. Financial Sector Liabilities increased $1.08 Trillion, or 10.8%, over the past four quarters and have now doubled over the past 23 quarters. This expansion is massive, unrelenting and historic, and goes far in explaining rampant asset inflation and seemingly endless financial market liquidity.
However, I’ll begin by noting that Commercial Banking Total Assets expanded at only a 1.2% annualized rate during the third quarter. This was down sharply from the second quarter’s 10.1% pace of expansion and the weakest growth since the Q1 2002 blip. Seasonally-adjusted “Net Acquisition of Financial Assets” actually contracted at an adjusted annualized rate of $67.2 billion during the quarter. And after gorging on Agency Debt for five quarters (up $226.7 billion, or 28%), Commercial Banks reduced holdings by an annualized $268.8 billion during the third quarter (as interest rates rose sharply, albeit temporarily). Bank Loans expanded at about a 5% rate during the quarter. Notably, Commercial Loans contracted by an annualized 9.0%, with these loans declining $103.5 billion (7.6%) y-o-y. Conversely, Mortgage Loans expanded at a 12.9% pace during the quarter and were up $301.9 billion (15.4%) y-o-y.
As for Commercial Bank liabilities, Checkable Deposits contracted at an annualized pace of $152 billion, while Miscellaneous Liabilities expanded by an annualized $219.3 billion. Foreign Banking Offices in the U.S. reduced financial assets holdings by an annualized $128.2 billion, with the liability Federal Funds and Securities RP (repurchase agreements) contracting by an annualized $100.4 billion.
Yet we certainly cannot nowadays associate slow bank asset growth with reduced overall Credit expansion. Once again “saving the day,” GSE Assets expanded at a 21.4% rate during the quarter to $2.80 Trillion. At an unprecedented seasonally-adjusted annualized increase of $568.9 billion, this was the strongest rate of GSE growth since the anxious fourth quarter of 1999. As “Buyers of First and Last Resort” for the banks, brokers, hedge funds and other speculators, the GSEs increased holdings of mortgage-backed securities during the quarter by an annualized $542 billion (45%). Over 12 months, GSE Assets inflated $345.6 billion, or 14.1%, compared with the 2002 rise of $247 billion. GSE Assets have ballooned an astonishing 155% over 23 quarters.
Federally-related Mortgage Pools (GSE MBS) increased at a 9.9% rate during the quarter to $3.37 Trillion, the strongest rate of growth in five quarters. MBS was up 9.3% over the past year (up 85% over 23 quarters). Asset-backed Securities (ABS) expanded at a 9.3% rate during the quarter to $2.56 Trillion, with 12-month gains of 13.6% (up 159% over 23 quarters). Total “Structured Finance” (combining GSE, MBS, and ABS assets) expanded during the quarter at an annualized $1.23 Trillion, or 13.4%, to $8.76 Trillion. Over the past year, “Structured Finance” has ballooned $938.3 billion, or 12.0% (up 123% over 23 quarters).
Security Brokers and Dealers increased assets by an annualized $107 billion (10% growth rate), down sharply from the second quarter’s risky 36.5% growth rate. Agency Holdings contracted at a notable annualized $214.3 billion, while Treasuries increased by an annualized $174.4 billion. Security Credit contracted at an annualized $87.6 billion. Miscellaneous Assets expanded at an annualize $187.9 billion. On the liability side, Security RPs (repurchase agreements) increased at an annualized $206.1 billion. Over the past four quarters, Security Broker and Dealer assets have increased 9.3% to $1.55 Trillion.
Federal Funds and Security Repurchase Agreements expanded at a 10.1% annualized rate to $1.487 Trillion, with four-quarter gains of 13.2% (up 81% over 23 quarters). Funding Corporations – “Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations” – saw asset holdings expand at an annualized $167.6 billion, or a pace of about 11%. Miscellaneous Liabilities increased by an annualized $187.4 billion.
Finance Companies (including “captives”) expanded assets during the quarter at a notable annualized $366.9 billion, or 28%. To fund this expansion, Corporate Bonds increased at an annualized $139.7 billion and Other Miscellaneous Liabilities expanded at an annualized $257.9 billion. Money Market Funds contracted by an annualized $223.1 billion, with holdings of Open Market Paper (commercial paper) down by an annualized $167.9 billion. Miscellaneous Assets expanded by an annualized $108.6 billion. Elsewhere, Real Estate Investment Trusts (REITs) expanded assets at a 27% annualized rate to $108 billion.
The Federal Reserve increased its holdings by $9.9 billion during the quarter to $778.9 billion, or 5.1% annualized. The Fed’s balance sheet was up $68.7 billion, or 9.7% y-o-y. Over the past four quarters, Federal Reserve growth has accounted for only about 6% of total financial sector expansion. .
Examining mortgage lending, Total Mortgage Borrowings increased at a 12.1% rate during the quarter to $9.242 Trillion. Over four quarters, Total Mortgage Credit surged $1.045 Trillion, or 12.8%. It is worth noting that Total Mortgage Borrowings increased $288 billion during 1996 and $337 billion during 1997. Since the beginning of 1998 (23 quarters), Total Mortgage Credit is up $3.98 Trillion (avg. $692 billion annually), or 76%. Total Household Debt was up 13.8% over the past year to $7.11 Trillion (up 78% over 23 quarters).
Examining third quarter government receipts and expenditures, Federal spending was up 8.6% y-o-y, while receipts were down 4.1% y-o-y. State & Local government spending was up 5.5% from third quarter 2002, while receipts were up 5.9%. Total government debt increased at an annualized rate of $557 billion during the quarter. Federal government debt increased at an annualized rate of $396 billion. State & Local debt increased at an annual rate of $161.3 billion.
It is also beneficial to take a close look at ballooning household assets and liabilities. The Balance Sheet of the Household Sector (including non-profit organizations) surpassed $51 Trillion for the first time during the third quarter. Total Assets increased $802.2 billion, or 6.3% annualized, and were up $4.53 Trillion, or 9.6%, over the past year. The value of Household Real Estate increased $290.8 billion during the quarter, or 8.2% annualized, to $14.55 Trillion (up $1.07 Trillion, or 7.9%, over four quarters). And despite massive borrowings, inflating values allowed Owners’ Real Estate Equity to increase $90 billion during the quarter to $7.9 Trillion. Total Financial Asset values increased $434.7 billion, or 5.4% annualized, to $32.47 Trillion (up $3.224 Trillion, or 11.0% over 4 quarters). Interestingly, Total Deposit holdings actually contacted $4.4 billion to $5.17 Trillion. On the other hand, Credit Market Instrument holdings jumped $61.9 billion, or 10.2% annualized, to $2.49 Trillion. Holdings of Agency securities actually jumped $140 billion (to $291.4 billion), easily the most conspicuous development with respect to household investment preference.
And while we must wait impatiently for the March release of the 4th quarter “Flow of Funds” report, third quarter data provide us some very useful insight. As for the almost four months of contracting money supply, unfolding during the third quarter were some rather profound developments with regard to the nature of financial sector liability creation. Commercial Banking Checkable Deposits were in sharp decline ($152.4 billion annualized). Time and Savings Deposits growth had slowed markedly, from an average annualized $371 billion over the previous six quarters to only $43.9 billion during the three months ended September 30th. And Money Market Fund deposits were in sharp decline ($223.1 billion annualized).