Federal Reserve Q3 2006 Z.1 “flow of funds” report.
Akin to current economic and market analysis, skillful examination of the Fed’s quarterly “Flow of Funds” report has become a more challenging endeavor. Yet one might be tempted to glance at the broad Credit aggregates and find little cause for delving into the detail. Total Credit Market Debt (Non-financial and Financial) increased $755 billion during the quarter (7.1% annualized), down from Q2’s $820 billion (7.8%) and little changed from Q3 2005’s $760 billion. Over the past year, Total Credit Market Debt increased $3.526 Trillion, or 8.8%. For perspective, Total Credit Market Borrowings increased $2.352 Trillion during 2002, $2.729 Trillion in 2003, $3.003 Trillion in 2004, and $3.436 Trillion in 2005.
Total Non-Financial Credit expanded at a 6.7% seasonally-adjusted annual rate (SAAR), unchanged from Q2 and down from Q1’s 9.5%. Importantly, however - and this pertains to the entire “Z.1” analysis – Credit and financial flow data trends should be contemplated in the context of the marked deceleration in nominal GDP growth over the past three quarters - from 9.0% to 5.9% to the third quarter’s 4.0%. And does the Flow of Funds provide insight to further our understanding of the paradox between reduced borrowings in the real economy and heightened liquidity in financial markets at home and abroad?
With home mortgage debt growth decelerating, Total Household Borrowings slowed to 6.8% SAAR, down from Q2’s 9.2%, Q1’s 9.7%, and Q4 2005’s 11.6%. Total Business Borrowings slipped somewhat to a 7.7% pace, down from Q2’s 8.4%, Q1’s 9.6% and Q4 2005’s 7.7%. Bucking the trend, State & Local Government Borrowings jumped to a 9.3% rate, up from Q2’s 6.6%, Q1’s 3.5%, and Q4 2005’s 9.7%. Enjoying booming receipts, Federal Government Borrowings nonetheless bounced back somewhat to a moderate 3.3% rate, reversing Q2’s negative 2.4% but below Q1’s 11.3% and Q4 2005’s 8.0%.
Continuing a prominent Q2 “Flow of Funds” development, the more intriguing aspect of Q3 data is buried in the nature of Financial Sphere ballooning. Don’t be fooled by the sharp slowdown in Credit market borrowings from the Fed’s aggregate “Domestic Financial Sectors” - which slowed to 5.6% from Q2’s 10.5% and Q1’s 8.6% pace. The contraction of GSE balance sheets is a partial explanation. Additionally, key funding sources for the unrelenting Financial Sphere expansion are not captured within “Credit Market Borrowings.”
I'll posit that ballooning securities finance (in particular, speculative securities leveraging along with booming M&A financings) has developed into a key force in ongoing system liquidity creation. Cutting to the chase a bit, “Fed Funds & Repos” expanded at a 26.9% rate during the quarter and “Funding Corps” grew 25% annualized. Broker/Dealer Assets ballooned at a blistering 28% pace during the quarter, expanding balance sheets much more rapidly than the Banks ($168.3bn vs. $39.5bn). Why the need for such aggressive expansion in the face of a slowing economy?
The impetus to Financial Sphere expansion provided by the U.S. housing slowdown and resulting economic moderation has been the major financial development of 2006. Or, stated differently, Wall Street has been eagerly prepared to take full advantage of the conclusion of a “tightening” cycle that never approached imposing actual financial tightening. The “Flow of Funds” clearly captures this major inflation of securities market-based Credit instruments.
During the first three quarters of the year, Broker/Dealer Assets expanded $427 billion, or 27% annualized, to $2.57 Trillion. For comparison, assets expanded on average $170 billion during the first half of the decade. Broker/Dealer Assets have now ballooned $750 billion, or 45%, in just the past two years. During Q3, Broker/Deader Financial Assets expanded $601 billion SAAR. Miscellaneous Assets ballooned $432 billion SAAR to $1.539 Trillion (up 54% y-o-y). Holdings of “Credit Market Instruments” expanded $192 billion SAAR during the quarter (to $546bn), the largest increase since Q4 2005. By major category, Treasuries increased SAAR $96 billion, Agency/GSE MBS $23 billion, and Corporate Bonds $65 billion.
Financing the historic Broker/Dealer Bubble, “Security Repos (net)” expanded $509 billion SAAR and Securities Credit from Banks $101 billion SAAR during the quarter. Year-to-date, the Liability “Repos” has expanded at a 41% rate to $965 billion and the Liability “Security Credit” 21.5% to $282 billion. In contrast, so far this year Broker/Dealer Credit Market Bond borrowings have increased $11.6 billion to $74 billion.
At the epicenter of securities finance, “Funding Corporations” (“Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations”) expanded assets $473 billion SAAR during the quarter, or 25% annualized, to $2.012 Trillion. Year-to-date, Funding Corps have grown at a 13.8% rate. Funding Corp Assets have ballooned almost a third in seven quarters. Their largest Asset – “Investment in Brokers and Dealers” – expanded $303 billion SAAR during the quarter to $902 billion (up 21% annualized y-t-d). On the “Funding Corp” Liability side, “Securities Loaned (Net)” expanded $336 billion SAAR during the quarter. Year-to-date, “Securities Loaned” has ballooned at a 36% rate to $1.214 Trillion. Notably, the Securities Loaned Liability has increased 59% since December 2004. Also on the Liability side, “Open Market Paper” (largely commercial paper) expanded $210 billion SAAR during the quarter. Year-to-date, Open Market Paper has grown at a 19% rate to $563 billion.
The Fed’s category “Federal Funds and Securities Repurchase Agreements” expanded $606 billion SAAR during the third quarter ($509 billion SAAR lent to the Broker/Dealers). Year-to-date, Fed Funds & Repo has ballooned $366 billion, or 24% annualized, to $2.371 Trillion, with a two-year gain of 42%. On the Liability side (the entities holding these Credit instruments), owed to Money Market Mutual Funds increased $266 billion SAAR during the quarter (to $368bn) and Rest of World $144 billion SAAR (to $805bn). ROW Fund Funds & Repo holdings have expanded at a 17% rate y-t-d.
Bubbling Securities Finance is certainly taking up any slack created from slowing mortgage debt growth. Total Mortgage Debt (TMD) expanded at an 8.4% rate to $13.033 Trillion. TMD was up $1.282 Trillion y-o-y, or 10.9%. For comparison, TMD increased $562 billion during 2000, $690 billion in 2001, $881 billion in 2002, $1.007 Trillion in 2003, $1.304 Trillion in 2004, and $1.468 Trillion last year, after annual growth averaged $269 billion during the nineties. During the third quarter, Home Mortgage Borrowings slowed to a 7.4% rate (to $10.029 Trillion), reducing y-o-y growth to 10.4%. At 13.4% annualized, Commercial Mortgage debt growth was little changed from Q2, with y-o-y growth of 14.8% (to $2.130 Trillion).
Impacted by slower mortgage borrowings, the booming Asset-Backed Securities (ABS) marketplace saw growth reduced to a still robust 10.6% annualized during the quarter to $3.323 Trillion, down from Q2’s 12.7% growth rate. ABS has expanded $468 billion, or 16.4%, over the past year and $1.011 Trillion, or 42%, during the past two years. GSE balance sheets contracted at a 3.7% rate during the quarter to $2.837 Trillion, a reversal from Q2’s 7.1% growth rate (GSE assets up 3% y-o-y). Outstanding GSE MBS expanded at an 8.3% rate during the quarter to $3.892 Trillion (up 7.6% y-o-y).
Certainly playing a prominent role in the intermediation of rapidly inflating “repo” and “Fed funds” Credit instruments (financing the Securities Finance Bubble), Money Market Funds (MMF) expanded at a 19% rate during the quarter to $2.167 Trillion. On a seasonally-adjusted and annualized basis, MMF assets increased $439 billion during the quarter, with Security Repos up $161 billion and Open Market Paper up $266 billion. MMF assets were up $290 billion, or 15.4%, over the past year.
Elsewhere, REIT liabilities expanded at a 9.2% pace to $607 billion (up 11% y-o-y). Savings Institution assets expanded at a 14.5% rate to $1.833 Trillion (up 9.8% y-o-y). Finance Company assets expanded at a 3.2% rate to $1.872 Trillion (up 5.3% y-o-y). And Credit Union assets grew at a 4.0% pace to $711 billion (up 3.7% y-o-y).
Bank balance sheet growth was sharply reduced during the quarter, impacted by the housing slowdown as well as the likely increased securitizing and selling of various types of loans (some into CDOs and other “structured finance” vehicles). Bank Mortgages expanded at a 6.7% rate, down from Q2’s 12.7% and Q1’s 8.8% pace. MBS holdings dropped $62 billion during the quarter, reducing y-o-y growth in MBS and Treasuries to 2.1%. Contracting Securities Credit reduced overall Bank Credit growth to 3.7% during the quarter, although keep in mind that many of the securities unloaded by the Banks ended up on the balance sheets of the Broker/Dealers and their hedge fund clients.
The “Rest of World” (ROW) continues to “recycle” extraordinary liquidity into the top-tier U.S. securities markets. ROW holdings of U.S. financial assets increased $343 billion during the quarter, or 11.8%, to $11.946 Trillion. On a seasonally-adjusted and annualized basis, ROW holdings ballooned $1.439 Trillion. In nominal dollars, Treasury holdings increased $41 billion to $2.070 Trillion, Agencies $53 billion to $1.131 Trillion, and Corporate Bonds $86 billion to $2.597 Trillion. Better illustrating the scope of foreign purchases in key markets during the quarter, on a seasonally-adjusted and annualized basis Treasury holdings increased $163 billion, Agency/MBS $213 billion, and Corporate Bonds $344 billion. Over the past year, holdings of Agency/MBS have increased $247 billion (28%) to $1.131 Trillion and Corporate Bonds $301 billion (13.1%) to $2.597 Trillion. Little wonder there has been such downward pressure on market yields (no “conundrum”). Over the same period, Foreign Direct Investment was up $111 billion (6.5%) to $1.820 Trillion.
The Household Balance Sheet continues to provide insight into consumer resiliency. Household Net Worth increased $775 billion during the quarter, up sharply from Q2’s $27 billion rise. Total Household Assets inflated $1.044 Trillion (6.3% annualized) during the quarter to $67.058 Trillion, while Liabilities increased $268 billion (8.4% ann.) to $12.995 Trillion. On the Asset side, Financial Assets increased $747 billion (7.5% ann.), with Deposits rising $158 billion (10.1% ann.). Household Real Estate increased $242 billion, or 4.4% annualized, to $22.42 Trillion. Over the past year, Household Assets inflated $4.608 Trillion, or 7.4%. Real Estate increased $1.781 Trillion (8.6%) and Financial Assets $2.616 Trillion (6.9%). Household Liabilities expanded “only” $1.106 Trillion, or 9.3%, over the past year. Household Net Worth, then, inflated $3.502 Trillion, or 6.9%, over the past year to $54.06 Trillion. Net Worth has inflated 40% in four years.