Federal Reserve Q2 2007 Z.1 “flow of funds” report.
Considering third-quarter financial market developments, it is tempting to view Q2 Credit analysis as somewhat less than timely and relevant. Yet the data do provide evidence of worsening unstable dynamics - in particular, an energized Financial Sphere expanding at breakneck speed, easily outdistancing the flagging Economic Sphere. Highlights for the quarter included double-digit growth rates for both Commercial Bank and Broker/Dealer balance sheets. The ABS market continued its streak of double-digit growth, and Agency MBS posted back-to-back quarters of double-digit expansion. The Money Market Complex expanded at an almost 17% rate. Rest of World (ROW) holdings of U.S. Assets expanded double-digit rates as well.
Overall, Total Net Borrowing in the Credit Markets increased at a SAAR (seasonally-adjusted and annualized rate) $3.757 TN during Q2 to $46.573 TN. This was down only slightly from Q1’s SAAR $3.784 TN, and, for perspective, compares to 2006’s growth of $3.825 TN, 2005’s $3.380 TN, 2004’s $3.085 TN, 2003’s $2.767 TN, and 2002’s $2.365 TN. Notably, Corporate borrowings expanded at a 10.7% rate during the quarter, State & Local governments 11.9%, and the Financial Sector 9.8%. Financial sector borrowings built on Q1’s brisk pace (9.7%) to the strongest rate of expansion in a year. And while recent Credit market turmoil has imposed borrowing restraint, it is worth noting that first-half corporate debt growth was at the fastest pace since 1999.
Total Non-Financial Debt expanded at a SAAR $2.080 TN (to $29.869TN), down somewhat from Q1’s $2265 TN. By sector, Household debt expanded SAAR $926bn (vs. Q1’s $908bn) to $13.292 TN; Non-Financial Corporations SAAR $626bn (vs. Q1’s $520bn) to $6.050 TN; Non-Farm Non-Corporate SAAR $348bn (vs. Q1’s 267bn) to $3.260 TN; Farm Business SAAR $5.1bn (vs. $20.6bn) to $210bn; and State & Local Govt. SAAR $246bn (vs. $224bn) to $2.130 TN. Accounting for more than all of Q2’s decline in Non-Financial Debt Growth, Federal Government borrowings actually contracted SAAR $71bn, compared to Q1’s expansion of SAAR $326bn. Federal government fiscal improvement will be fleeting.
Continuing a trend that became quite pronounced last year, near double-digit financial sector growth far exceeds that of the real economy. Financial Sector Credit Market Borrowings (FCMB) increased SAAR $1.423 TN (up from Q1’s $1.377 TN) to $14.866 TN. For perspective, FCMB expanded $1.282 TN during 2006, $1.092 TN in 2005, $980bn in 2004, $1.053 TN in 2003, and $869bn in 2002. It is illuminating to note the type of Credit instruments that financed the financial sector expansion. During the quarter, “Open Market Paper” increased SAAR $360bn, “GSE Issues” SAAR $99bn, Agency-and GSE-backed securities SAAR $544bn, Corporate bonds SAAR $365bn, Bank Loans SAAR $47bn, and (bank liabilities) Mortgages SAAR $8.2bn. It will likely be some time before “Open Market Paper” and Corporate bonds expand at such rates.
The Wall Street Bubble was alive and well during Q2. The Broker/Dealers expanded Assets at SAAR $703bn to $3.155 TN. Broker/Dealer Assets inflated $413.1bn (nominal) during the first half, or 30.1% annualized. This expansion was second only to 2006’s full-year $615bn growth. For perspective, Broker/Dealer Assets increased $282bn during 2005, $232 in 2004, and $278 in 2003 – and actually contracted $130bn during 2002. Examining the nature of Asset growth during the quarter, Corp & Foreign bonds increased SAAR $84bn, Securities Credit SAAR $219bn, and “Miscellaneous” SAAR $621bn. Treasury holdings declined SAAR $157bn and Agency/GSE MBS fell SAAR $101bn. On the Liability Side, Miscellaneous Liabilities increased SAAR $525bn, Securities Credit SAAR $95bn, and Trade Payables $55bn.
Wall Street “structured finance” enjoyed a booming and, perhaps, foretelling Q2. GSE Assets expanded SAAR $176bn (to $2.923TN), the strongest growth in a year. Still, GSE assets were up only 1.1% y-o-y. Agency MBS surged SAAR $544bn, up from Q1’s $499bn and the year earlier $300bn. Agency MBS expanded at a 12.3% rate during the quarter, with one-year gains of 10.8%. Asset-Backed Securities expanded SAAR $545bn (to $4.295 TN), down only modestly from Q1’s $574bn. And despite the slowest quarter in some time, the ABS market still enjoyed a 13.3% growth rate for the quarter and 18.1% growth over the past year. The ABS market has expanded 63% during the past 10 quarters, extraordinary growth that hit the wall with a thud with the homecoming of market tumult in Q3.
Interestingly, Total Mortgage Debt (TMD) expanded SAAR $1.167 TN (to $13.982 TN), up from Q1’s SAAR $1.087 TN. TMD actually expanded at a robust 9.0% rate, the largest expansion since Q3 2006 - suggesting that ultra-easy Credit Conditions endured outside of subprime. Even Home Mortgage debt growth accelerated, rising to a 7.7% rate from Q1’s 7.3%. Meanwhile, the Commercial Mortgage lending boom went to “blow-off” extremes – expanding at a 15.6% pace (vs. Q1’s 10.1%). For the quarter, Home Mortgage lending expanded SAAR $756bn to $10.750 TN and Commercial Mortgage a record SAAR $344bn to $2.344 TN. Total Mortgage debt has expanded 9.2% over the past year and 24% over two years, with Commercial mortgage debt up 13.9% y-o-y and 31%. It will be fascinating to learn how dramatically mortgage debt growth slowed during Q3. Credit restraint hit all sectors.
Quite possibly, Q3 will see record banking sector asset growth, both building on Q2 momentum and taking up the slack created by the Breakdown of Wall Street Risk Intermediation. During the second quarter, Commercial Banking Assets expanded SAAR $1.037 TN to $10.455 TN. For comparison, Bank Assets grew $897bn during 2006, $763bn in 2005, $762bn in 2004, $495bn in 2003 and $477bn in 2002. On a percentage basis, Q2 experienced Bank Asset growth of 10.5%, with Loans up 8.9%. Over the past year, Bank Loans have expanded 9.0%, with a two-year gain of 22.9%. Bank holdings of Mortgage loans expanded at a 9.9% rate during the quarter (to $3.462TN), with one-year growth of 10.5%. Corporate Bond holdings jumped $44.4bn (22.1% annualized) to $848bn, with one-year growth of 15.5%. It’s an inopportune time in the Credit Cycle for the banking system to expand so aggressively.
There were some interesting happenings on the Bank Liability side – the new Credit instruments created in the process of financing robust asset growth. Total Deposit growth slowed markedly to a 3.3% rate during the quarter to $6.162 TN (up 7.6% y-o-y). “Fed Funds & Net Repo” Liabilities expanded at a 14.3% pace to $1.327 TN (up 11.7% y-o-y). Credit Market Liabilities expanded at a brisk 18.5% rate to $1.063 TN (up 19.4% y-o-y). Miscellaneous Bank Liabilities grew at a 36.3% pace to $1.942 TN (up 10.5% y-o-y), and Bond Liabilities increased at a 22.9% rate to $625bn (up 18.3% y-o-y). One can make a strong argument that it has not been the ideal environment to aggressively expand capital markets liabilities to fund risky loan growth.
Money Market Mutual Funds (MMF) expanded a robust SAAR $442bn to $2.490 TN. MMF assets were up 16.7% annualized during the quarter, 20.4% y-o-y and 35.9% over two years. “Security RP” holdings expanded SAAR $85.8bn during the quarter to $413bn. Credit Market Instruments increased SAAR $350.8bn, with Open Market Paper up SAAR $90.4bn (to $664bn), Treasury Securities up SAAR $38.7bn (to $89bn), Agency- and GSE MBS up SAAR $31.1bn (to 126bn), Municipal Securities SAAR $58.4bn (to $399bn), and Corporate & Foreign Bonds SAAR $132bn (to $422bn). And it has definitely been a risky backdrop for enormous money fund intermediation of late-cycle risky Credits.
“Open Market Paper” expanded a record SAAR $410bn during Q2 to $2.110 TN. This was a notable 22.4% rate of expansion during the quarter, with one-year growth of 16.7%. Virtually all Q2 growth was in Commercial Paper, although this amount and more will be reversed during the current quarter. The ABS sector issued a record SAAR $295bn of (asset-backed) Commercial Paper during the quarter (to $885bn). At SAAR $140.7bn, “Funding Corps” were the largest purchasers of Open Market Paper. Funding Corp Asset growth slowed during Q2 (to 7.1% ann.), reducing its first-half growth rate to 20.7% (to $1.681 TN). Fed Funds & Net Repo Asset growth also slowed (to an 8.2% rate), reducing the pace of first-half growth to a still blistering 19.0% (to $2.731TN)
Delving briefly into other financial operators, Life Insurance Cos. expanded Assets at a 10.2% rate during the quarter to $4.868 TN (up 8.7% y-o-y); Financial Companies at a 0.7% rate to $1.896 TN (up 2.1% y-o-y); Saving Institutions at a 1.3% rate to $1.673 TN (down 5.4% y-o-y); Credit Unions up at a 3.9% rate to $749bn (up 6.4% y-o-y); and REIT assets down at a 7.1% rate to $391bn (up 7.6% y-o-y).
As always, the Household (& Non-Profit) Balance Sheet illuminates powerful Credit Bubble dynamics. The value of Household Assets inflated $1.510 TN (nominal) during the quarter, or 8.6% annualized, to $71.672 TN. And with Household Liabilities increasing “only” $301bn, or 8.9% annualized, to $13.813 TN, Household Net Worth inflated an additional $1.206 TN, or 8.5% annualized, during the quarter to a record $57.859 TN. Expanding at an 11% annualized rate, Financial Assets increased $1.186 TN (nominal) to $44.284 TN. Real Estate Assets grew a moderate $274bn, or 4.8% annualized, to $23.193 TN.
Over the past year, Financial Asset holdings have increased $3.980 TN, or 9.9%, and Real Estate Assets $1.135 TN, or 5.1%. Total Household Assets have ballooned $5.271 TN, or 7.9%, in four quarters. With Liabilities up $1.076 TN, or 8.5%, Household Net Worth has inflated $4.195 TN over the past year, or 7.8%. Household Net Worth is up $8.512 TN, or 17.2%, in two years, certainly supporting consumer confidence and expenditures.
The Rest of World (ROW) Balance Sheet also typically exposes Credit Bubble effects. This quarter’s report, unfortunately, is somewhat convoluted – and with major revisions to confuse the issue. For the quarter, the ROW acquired U.S. Financial Assets at an unprecedented SAAR $2.535 TN, while ROW U.S. Liabilities increased a record SAAR $1.934. In nominal dollars for Q2, ROW Assets holdings increased an enormous $522bn, or 14.1% annualized, to (a heavily revised) $15.366 TN. Credit Market holdings increased $215bn, or 15% annualized, to $6.947 TN. Treasury Holdings dipped $7.8bn to $2.185 TN, while Agencies jumped $86bn to $1.134 TN. Corporate Bond holdings rose $111bn to $2.990 TN.
Over the past year, ROW holdings of U.S. Assets were up an unfathomable $2.659 TN, or 20.9% (ROW Liabilities up $1.172 TN to $6.877 TN). Credit Market holdings have increased $919bn, or 15.2%. Elsewhere, Security Repos increased $265bn (28.2%) y-o-y, and Direct Investment rose $226bn (11.5%). Corporate Bonds (that include ABS) increased $787bn, while “Other” Assets were up almost $400bn and Deposits $118bn.