Federal Reserve Q4 2006 Z.1 “flow of funds” report.
Fourth quarter Credit data have arrived. Despite the deepening housing downturn, the year came to an end with Total Non-Financial debt expanding at a robust 7.9% pace, up from Q3’s 6.5% and Q2’s 6.8%. And while Total Household Borrowings decelerated to a 6.4% rate during the fourth quarter (down from Q3’s 7.8%), Non-Financial Corporate borrowings surged to a 10.9% growth rate (up from Q3’s 5.0%). Financial Sector Credit Market Borrowings increased at a 7.2% pace (up from 5.8%). Federal debt growth was stable at 3.3% during the quarter, with Receipts up 11% and Expenditures up 5.5% y-o-y. State & Local government borrowings accelerated to a 13.5% growth rate (up from Q3’s 8.2%), as Receipts grew 5.5% and Expenditures increased 4.5% y-o-y.
After a prolonged Credit Bubble, percentage changes don’t do justice. Nominal debt growth numbers are more illuminating, in the case of the fourth quarter “seasonally-adjusted and annualized rates” (SAAR). During Q4, Total Credit Market Borrowings jumped to $3.567 TN SAAR, up from Q3’s $3.025 TN SAAR. For comparison, Total Credit Market Borrowings accelerated from $2.348 TN in 2002, to $2.725 TN in 2003, to $3.002 TN in 2004, to $3.403 TN in 2005, and to $3.555 TN for all of 2006. And while Household Sector borrowings slowed to $838bn SAAR (from Q3’s $928bn), Non-Financial Corporate borrowings surged to $605bn SAAR (from $276bn). For perspective, Households borrowings increased $1.239 TN during 2005, and Non-Financial Corporate borrowings expanded $245bn.
Last year was an extraordinary year for Macro Credit Analysis. Non-Financial debt growth decelerated from 2005’s 9.4% to 7.9%. In nominal dollars, Non-Financial debt growth slowed to $2.100 TN from the previous year’s $2.279 TN. Students of Credit theory could have justifiably expected this development to be problematic for inflated asset markets and the US and global Bubble economies generally. Importantly, however, total US system Credit and marketplace liquidity were buttressed by accelerating Financial Sector debt growth (from 8.7% to 9.3%). In nominal dollars, Financial Sector Credit Market debt growth (that excludes, among others, bank deposit growth) increased from 2005’s $1.040 TN to a record $1.200 TN, although this in no way reflected the entirety of Financial Sector liability expansion.
The ballooning Financial Sphere - financing robust mortgage and corporate Credit growth, and at the same time positioning in the securities markets to profit from unfolding Economic Sphere and Fed rate moderation - was a key Macro Credit theme for 2006. Rapid system Credit and liquidity creation way beyond the needs of the real economy fueled rampant financial asset inflation at home and abroad.
Nowhere was this dynamic more conspicuous than within the Broker/Dealer industry Balance Sheet. Broker/Dealer Assets expanded $515bn SAAR during the quarter, or 24.3% annualized. The Asset “Security Credit” grew $150bn SAAR, Treasuries $220bn SAAR, Corporate & Foreign Bonds $91bn SAAR, and Miscellaneous Assets $91bn SAAR. On the Liability side, Securities “Repo” ballooned $406.8bn SAAR during the quarter, financing the vast majority of rampant asset expansion.
For the year, Broker/Dealer Assets expanded a blistering (responsible?) 28.9% to $2.742 TN, posting an incredible 2-year gain of $897bn, or 49%. For perspective, Broker/Dealer Assets expanded $615bn during 2006, $282bn in 2005, $232bn in 2004, $278 in 2003, and declined $130bn during 2002. Keep in mind that 2006 Broker/Dealer asset growth was double the previous record (2005’s $282bn) and approached triple 2000’s $220bn (at the time a record). By Asset category, Credit Market Instruments were up 22.2% y-o-y to $583bn, Misc. Assets 33% to $1.60 TN, and Security Credit 25.7% to $292bn. On the Liability side, Security “Repos” (net) surged 46.1% y-o-y to $1.072 TN, “Due to Affiliates” increased 14% to $1.137 TN, and Security Credit 18.9% to $958bn.
In the Enigmatic World of Contemporary Securities Finance, there is an entangled interplay between the Wall Street firms, the securities “repo” market, “Funding Corps” (“Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations”), and the “money” market. The ongoing ballooning of these various securities financing vehicles is nothing short of stunning. “Federal Funds and Security Repurchase Agreements” Liabilities surged $484bn (24.2%) last year to $2.491 TN, with 2-year growth of $800bn (50.9%). This market has almost doubled since the end of 2002. For comparison, “Repos” increased $352bn during 2005, $83bn in 2004, $227bn in 2003, and $107bn in 2002. “Funding Corps” expanded $286bn (15.7%) last year to $2.001 TN, with a 2-year gain of $579bn (38%).
And while there is definitely a “double-counting” issue between the Fed’s different debt and Credit intermediation categories, it is nonetheless worth noting that Open Market Paper (chiefly commercial paper), expanded at a 24% rate during Q4 and 20.8% for the year to $2.216 TN. Open Market Paper has expanded $645bn (41.4%) during the past two years. Home for much of this new finance, Money Market Fund Assets expanded at a 27% pace during Q4. For 2006, Money Fund Assets jumped $306bn, or 15.2%, to $2.313 TN, second only to 2001’s $429bn (the year, not coincidently, the GSE’s expanded a record $344bn). At $608bn, Open Market Paper comprises the largest Money Market Fund holding, followed by Security RPs ($395bn), Municipal Securities ($370bn) and Corporate Bonds including ABS ($368bn). Funding Corps Assets declined $1bn in 2002, increased $78bn in 2003 and $70bn in 2004, then surged $293bn in 2005.
One can conceptualize the GSEs having a few years back handed the Credit Bubble baton to the Wall Street firms, with the "money" markets now catering to the ballooning speculator community rather than the mortgage agencies. It is interesting to compare the assets held by Money Market Mutual Funds at the end of the year to those at the conclusion of 2002 (MMFA having increased only $90 billion after peaking in 2002). Agency/GSE Securities have declined from $333bn to $131bn, and Treasuries have dropped from $142bn to $83bn. Meanwhile, Security RPs have jumped from $273bn to $395bn, and Corporate Bonds (including ABS) have increased from $228bn to $368bn.
Total Mortgage Debt (TMD) expanded $1.172 TN (9.7%) during 2006. This was an enormous expansion, especially considering the rapidly slowing housing markets, though a notable deceleration from 2005’s blockbuster $1.462 TN (13.7%) growth. For perspective, TMD expanded an average $268bn annually during the nineties and $888bn annually during the first half of this decade. For the quarter, Home Mortgage borrowings slowed to a 6.1% pace, while Commercial Mortgage debt growth accelerated to a 15.6% rate. For the year, Home Mortgage borrowings increased 8.8% and Commercial 15.6%. Over two years, TMD jumped 25% (Home up 24%, Commercial up 32%). TMD more than doubled (109%) in seven years.
GSE Assets were little changed during Q4 and expanded only $35.6bn during 2006 (1.3%) to $2.841 TN. Agency MBS expanded $239bn SAAR (7.5% pace) during the quarter. For the year, Agency MBS grew $288bn (7.8%) to $3.965 TN, up sharply from 2005's growth to the strongest expansion since 2003. Yet it remains the ABS market leading the Wall Street securitization boom. Outstanding ABS increased $523bn SAAR (16% pace) during Q4 and jumped $533bn, or 17.4%, for the year. The ABS market has inflated an incredible $1.197 TN, or 49.8%, in just two years, and has ballooned 174% so far this decade.
Wachovia’s purchase of the thrift Golden West Financial inconveniently distorted Q4 bank Credit growth data. For the year, Bank Assets expanded $880bn, or 9.4%, to $10.204 TN (up 19.2% in 2yrs). Bank Credit surged $906bn, or 12.1%, to $8.363 TN (up 23.5% in 2yrs), with Total Bank Loans increasing 13.5% during 2006 (up 26.6% in 2yrs) to $6.113 TN. Bank Mortgage loans (including the addition of the Golden West portfolio) expanded 15% during the year to $3.403 TN. Bank holdings of Corporate Bonds jumped 13.8% to $781bn (2-yr gain of 40%).
On the Bank Liability side, Total Deposits expanded at a 13.7% pace during the quarter to $6.016 TN, with a one-year gain of $527bn, or 9.6%. Bank “Repos” (liabilities netted against assets) increased $149bn (13.7%) during 2006 to $1.240 TN. The Liability Credit Market Instruments expanded 21% y-o-y to $998bn. Miscellaneous Liabilities were up 7.2% during the year to $1.812 TN.
Elsewhere, Credit Unions expanded at a 4.4% pace during the quarter and 4.8% for the year to $719bn, and Finance Companies grew 4.1% and 1.7% to $1.889 TN. REIT Liabilities expanded at 12.8% rate during the quarter and were up 14.0% for the year to $631bn. Life Insurance Assets expanded at a 12.1% during the quarter and 8.2% for the year to $4.709 TN. Federal Reserve Assets increased $29.6bn last year (3.4%) to $908bn, or less than 1% of the increase in total system Credit.
Definitely not as trivial, Rest of World (ROW) holdings of U.S. Financial Assets expanded $1.671 TN SAAR during the fourth quarter and $1.527 TN for the year. This was more than a 50% increase from 2005’s $1.041 TN increase, and compares to 2004’s $1.321 TN, 2003’s $824bn, 2002’s $771bn and 2001’s $658bn. For the year, ROW Treasury holdings increased $141bn (7.1%) to $2.135 TN, and Agency holdings surged $220bn (23%) to $1.173 TN. For both Treasuries and Agencies, ROW purchases accounted for the majority of new issuance, and this has generally been the case now for the past several years (Conundrum?). Holdings of Corporate Bonds (including ABS) jumped $424bn (18.3%) during the year to $2.737 TN, with a 2-year gain of $676bn (32.8%). Foreign Direct Investment was up 11% y-o-y to $2.074 TN.
The Household (and Non-Profits) Balance Sheet, as always, provides invaluable Credit Bubble Insight. For the quarter, Total Household Assets expanded $1.641 TN, or 9.8% annualized, to a record $68.920 TN. This surge in financial wealth was led by a $1.356 TN (13.3% annualized) increase in Financial Assets. Mutual Fund holdings surged $320bn (28% annualized) during the fourth quarter to $4.963 TN. This significantly offset the slowdown in the housing inflation “wealth effect”, which fell to $246bn during the quarter (4.4% annualized). And with Household Liabilities increasing “only” $266bn (8.2% annualized), Household Net Worth surged a robust $1.375 TN (10.1% annualized) during the quarter to a record $55.626 TN. For the entire year, Household Assets jumped $4.906 TN (7.7%), with Real Estate up $1.464 TN (6.9%) and Financial Assets inflating $3.230 TN (8.3%, with Mutual Funds up $841bn, or 20.4%). With Liabilities increasing $1.074 TN (8.8%) during 2006, Net Worth surged $3.832 TN (7.4%). Household Net Worth has inflated $15.937 TN, or 40%, over the past four years.
Fueled by prolonged Credit excess, National Income expanded 8.2% during 2006 to $11.698 TN, the strongest pace of growth since 1988. Total Compensation increased 6.4%, the largest gain since 2000’s 7.9%. For comparison, Total Compensation increased 2.8% in 2001, 2.5% in 2002, 3.8% in 2003, 5.1% in 2004, and 5.7% in 2005.
There are key aspects of analysis that the Z.1 helps to confirm. First, in the context of ongoing Credit excesses, the 2006 moderation in mortgage Credit creation was more than offset by a sharp increase in Corporate and Financial Sector borrowings. Securities finance, in particular, exemplified by the growth in Broker/Dealer, “Repo,” “Funding Corp,” and “Open Market Paper,” was nothing short of spectacular. Rampant domestic Credit growth was ample to finance an ongoing economic boom, unprecedented Current Account Deficits, and general "Bubble Economy" asset inflation. Outflows from massive U.S. Current Account Deficits coupled with heightened speculative outflows were major sources instigating global liquidity excess, flows that were then recycled back to U.S. financial markets where they were “recycled” yet again into unrestrained financial excess.