Federal Reserve Q1 2008 Z.1 “flow of funds” report.
I’ve been eagerly awaiting the Q1 2008 Federal Reserve “flow of funds” Credit report. In particular, I have been keen to explore two key first quarter dynamics. First, Q1 was historic for the breakdown in “Wall Street finance” and the freezing up of most securitization markets. Second, the U.S. Bubble economy was notably resilient in the face of extreme Credit market tumult. The question then became: What types and sources of Credit took up the slack?
To begin with, Non-Financial Debt Growth (NFDG) expanded during the quarter at a respectable 6.5% annualized rate – a rate sufficient to at least keep the general economy from sinking into negative “output” growth. And while 6.5% was a meaningful decline from Q4’s 7.5%, I’ll note that it compares to an annual average of 5.4% NFDG growth throughout the decade of the nineties.
Examining Q1 Non-Financial Credit growth in somewhat more detail, Total Household Debt Growth slowed sharply to 3.5% from Q4’s 6.1%, as Household Mortgage Borrowings growth was cut almost in half from Q4’s 5.8% to 3.0%. Yet this was largely offset by a notable 9.2% annualized expansion in total Business Debt Growth (down from Q4’s 10.8%), along with a 9.5% rate of federal debt expansion (up from Q4’s 5.1%). At the same time, state & local debt expanded 6.4% annualized during Q1 (down from Q4’s 7.7%) - this despite turmoil throughout the muni debt markets.
Not surprisingly, Financial Sector Debt Growth (FDG) slowed sharply. After expanding 15.8% annualized during 2007’s Q3 and 8.8% in Q4, FDG slowed to a 5.1% pace during the first quarter. This is largely explained by contractions in both Asset-backed Securities (ABS) and “Open Market Paper” (chiefly commercial paper).
These days, in particular, useful perspective is garnered from examining Credit data at “seasonally-adjusted and annualized rates” (SAAR). “Total Net Borrowing” (non-financial and financial) expanded at a SAAR $3.115 TN during Q1. This was down meaningfully from Q4’s $3.693 TN and 2007’s annual $4.055 TN increase. For perspective, however, one can compare Q1’s rate of Credit expansion to 2006’s $3.875 TN, 2005’s $3.414 TN, 2004’s $3.057 TN, 2003’s $2.771 TN, and 2002’s $2.362 TN.
Importantly for the real economy, Non-Financial Credit Market Borrowings slowed only moderately to $2.036 TN during Q1 (down from Q4’s $2.316 TN and 2007’s annual $2.367 TN), although this should be noted as significant growth in the face of the period’s severe Credit market stains. It is worth noting that annual Non-Financial Credit Growth surpassed $1.0 TN for the first time in 1998 and $2.0 TN for the first time in 2005. Non-Financial debt growth averaged $701bn annually during the nineties, and despite the mortgage bust and Credit turmoil the system is still currently running at about three-times this pace.
A key theme of Q1 analysis is the divergence between the marked slowdown in asset-based lending and the continued readily available finance for much of the real economy. Total Mortgage Debt (TMD) expanded SAAR $581bn, down from Q4’s SAAR $988bn and 2007’s growth of $1.092 TN. In percentage terms, TMD expanded at a 3.6% pace, with Household Mortgage Debt increasing at a 2.4% rate and Commercial at 6.8%. Over the past year, TMD expanded 6.9%, with Household Mortgage Debt expanding 5.4% and Commercial 12.2%.
The breakdown in the market for Wall Street “private-label” mortgages is evident in Q1’s contraction in ABS. Through the first eight years of this decade, the ABS market had almost doubled in size. The greatest excesses were in 2005 and 2006, years of 25.7% and 23.6% growth, respectively. Growth slowed markedly to 4.4% last year, with Q4 posting an actual decline. The ABS market contracted at a 7.4% rate during Q1, or SAAR negative $305bn to $4.148 TN - reflecting the profound tightening of Credit for non-“conventional” mortgages. The ABS market has posted no growth over the past year (at $4.148 TN).
The expansion of GSE guarantees and balance sheets certainly took up considerable Credit slack. Growth in the (conventional) Agency MBS market slowed as well, from Q4’s overheated 20.8% rate to Q1’s still strong 11.7%. This placed one-year growth at a notable $639bn, or 16.2%, to $4.595 TN. GSE (holdings) growth slowed from Q4’s 11.7% to 5.8%. GSE holdings have expanded $332bn, or 11.5%, over the past year to $3.220 TN.
Interestingly, Broker/Dealer assets posted double-digit growth during the quarter (by choice?). After contracting at a 13.7% annualized rate during Q4, the Broker/Dealers expanded at an 11.8% rate during Q1 to $3.183 TN. One year growth has been reduced to 5.4%, although 2-year Broker/Dealer growth remains a notable (and problematic) 39%. Examining Broker/Dealer asset growth for the quarter, Credit Market Instruments expanded at a 33% annualized rate to $869bn, and Securities Credit grew at a 45% rate to $363bn. On the liabilities side, “Securities Repo” expanded at a 20% rate to $1.205 TN.
Money Fund Assets expanded at a 46% annual rate during the quarter to $3.408 TN. In SAAR terms, Assets expanded at an unprecedented $1.549 TN, up from Q4’s SAAR $820bn. By Asset category, Agency & GSE securities expanded SAAR $463bn, Treasury Securities SAAR $374bn, Open Market Paper SAAR $270bn, and Corporate Bonds SAAR $114bn. Over the past year, Money Fund Assets ballooned $1.018 TN, or 42.6% (2-yr growth 69%). This risk intermediation has played an instrumented if unheralded role in sustaining general Credit expansion.
It was, as well, an interesting quarter for the Banking sector. Bank Assets expanded at a 10.0% rate during the quarter, down somewhat from Q4’s 11.3%. In SAAR terms, Bank Assets increased $710bn during the quarter, to $11.474 TN. Bank Assets posted a one-year gain of 12.6% ($1.285 TN) and 2-year rise of 20.7% ($1.970 TN). During Q1, Total Loans expanded SAAR $336bn and Miscellaneous Assets SAAR $324bn. Mortgages expanded SAAR $299bn, down from Q4’s SAAR $518bn. Securities Credit dropped SAAR $203bn, after increasing SAAR $103bn during Q4. Holdings of both Treasuries and Agencies declined modestly during the quarter, offset by increases in municipal and corporate bonds.
Clearly, the breakdown of key securitization markets was mitigated during the quarter by double-digit growth in Bank Assets, agency MBS, Broker/Dealer Assets and Money Fund Assets. One can also safely assume that such strong growth in key financial sectors goes far in explaining the resiliency of the U.S. Bubble economy in the face of imploding Wall Street finance. Yet there are obvious questions revolving around the sustainability and consequences of such expansion.
As usual, the Household (and non-profit) Balance Sheet provides important clues regarding the underlying performance of the U.S. Bubble Economy. During Q1, Household Assets declined $1.590 TN (8.8% annualized) to $70.466 TN, led by a $1.334 TN (11.8% annualized) fall in Financial Assets values and a $305bn (5.5% annualized) drop in Real Estate. And with Liabilities increasing $106bn (3% annualized), Household Net Worth contracted a meaningful $1.696 TN (11.8% annualized). Over the past year, Household Assets have increased only $309bn (0.4%). And with Liabilities growing $871bn (6.8%), Household Net Worth dropped $563bn from a year earlier. This is in sharp contrast to the almost $12.0 TN surge in Household Net Worth during the preceding three years. This negative wealth effect has and will continue to place a drag on consumption. It should be noted, however, that so far resilient 4.5% y-o-y income growth has worked somewhat to bolster spending in the face of declining wealth.
First quarter data provide important corroboration for my contention that the U.S. Bubble Economy is sustained only by huge ongoing Credit growth – unusually risky ("pre-economic adjustment") Credit that must increasingly be intermediated by the Banking system, the GSEs and the Money Fund complex. With Wall Street finance having lost its perceived “moneyness,” the ongoing U.S. Credit expansion will only be sustained by rampant growth of instruments that retain the perception of safety and liquidity – namely, Treasuries, agency debt and MBS, Bank Liabilities and Money Fund “deposits.” And, at least for the first quarter, double-digit growth virtually across all these key sectors generated the necessary SAAR $2.036 TN of Non-financial Credit and SAAR $3.115 TN of total system Credit to prop up an acutely vulnerable economic Bubble. But at what cost? And for how long does today's functional "money" - being inflated at double-digit rates through the intermediation of risky Credits - retain its "moneyness"?
The “Rest of World” (ROW) page of the Fed’s Z.1 report always provides a good place to start when it comes to trying to gauge the scope of the global “recycling” effort required to redirect excess dollar liquidity back to the U.S. financial sector. On average, ROW acquired $166bn of our Credit Market Instruments annually during the nineties to “recycle” our Current Account Deficits and speculative dollar outflows. These purchases jumped to $467bn in 2002, to $583bn in 2003, $854bn in 2004, $749bn in 2005, $855bn in 2006, and $827bn in 2007. And despite the weak dollar, a rapidly slowing economy, and severe U.S. Credit tumult the intractable dollar “recycling” requirement had ROW acquiring U.S. Credit instruments at a stunning SAAR $996bn during the quarter. This is an enormous U.S. and global problem.
Total ROW holdings of U.S. Financial Assets have expanded $1.383 TN over the past year to $15.507 TN. It is no coincidence that this growth closely matches the increase in International Reserve Assets over the past year ($1.426 TN). And the various forms of Acute Global Monetary Disorder that have taken root are certainly a consequence of this increasingly Unwieldy Pool of Excess Global Finance. Crude oil and energy prices have surged better than 40% so far this year (natural gas up 70%), with the Goldman Sachs Commodities index sporting a y-t-d gain of 38%. Moreover, today’s moon shot in crude and commodities provides further warning as to the newfound degree of Global Price Instability that has emerged from a dysfunctional U.S. Credit mechanism and global financial “system.”