Federal Reserve Q3 2008 Z.1 “flow of funds” report.
As I have highlighted in the past, Total Non-Financial Credit (NFC) expanded $578bn in 1994. By 1998, annual NFC growth exceeded $1.0 TN for the first time. After year 2000’s recessionary pullback, by 2002 NFC growth was up to a record $1.412 TN, followed by 2003’s $1.677 TN, 2004’s $1.991 TN, 2005’s $2.322 TN, 2006’s $2.422 TN, and 2007’s $2.523 TN. From my analytical perspective, it has always been a case of the inevitable (Credit and Economic Bubbles') predicament of an impaired (post-Bubble) Credit system not having the capacity to create sufficient new Credit to stem financial and economic implosion.
To this point, a barrage of unprecedented monetary and fiscal policy responses has restrained the forces of systemic collapse. On a quarterly basis the Federal Reserve's Z.1 “Flow of Funds” report will help us better appreciate the profound effects the bursting of the Credit Bubble - and resulting policymaking -are exerting upon the underlying functioning of the Credit system and real economy.
Total Non-Financial Credit expanded at a surprising 7.2% rate during Q3, up sharply from Q2’s 3.1% pace to the most robust Credit growth since Q4 2007. By sector, Household Debt actually contracted at a 0.8% rate, down from Q2’s 0.6% growth and compared to 2007’s annual increase of 6.8%. Household Mortgage Debt contracted at an unprecedented 2.4% rate. Corporate borrowings slowed to a 3.7% pace from Q2’s 5.6%. This was a marked slowdown from the 13.2% surge in Corporate debt growth for all of 2007. During the quarter, State & Local Governments increased borrowings at a 2.9% pace. This was up from Q2’s 0.8%, but was much slower than 2007’s 9.3%. With private sector Credit growth now struggling mightily, public finance was forced to really take up the slack. Federal Government debt expanded at a 39.2% pace, playing a decisive role in generating sufficient system-wide Credit expansion.
On a Seasonally-Adjusted and Annualized Rate (SAAR), Total Non-Financial Credit expanded $2.348 TN during the quarter – a quantity of new finance that would be in the analytical ballpark (down only marginally from $2007’s $2.5 TN growth) to restrain the forces of systemic collapse. But of this amount, Federal Government borrowings accounted for SAAR $2.079 TN, or almost 90% of the Q3 Credit expansion.
With even an unsustainable $2.0 TN annual pace of federal borrowings failing to reverse the downward economic spiral, the Federal Reserve this week was compelled to signal in no uncertain terms that policymakers “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”
In tandem with Treasury efforts, the Federal Reserve expanded “Fed Credit” SAAR $2.353 TN during Q3. This unprecedented ballooning accommodated deleveraging and helped offset a sharp decline in lending throughout the financial sector. “Fed Funds and Repos” contracted SAAR $969bn during the quarter, while “Open Market Paper” declined SAAR $580bn. Savings Institutions reduced assets at SAAR $1.281 TN, partially explained by assets from troubled S&Ls having been shifted to commercial banks. Bank Credit at “Foreign Banking Offices in U.S.” contracted at SAAR $415bn, and lending at Finance Companies dropped SAAR $113bn. The Asset-Backed Securities (ABS) market shrank SAAR $419bn during Q3. After Q2’s SAAR $913bn contraction, Security Brokers and Dealers expanded SAAR $12.6bn.
Yet the Fed was not all by its lonesome expanding system Credit. Total Bank Credit actually expanded at a robust SAAR $1.365 TN - at least somewhat receptive to the “buyer of last resort” roll for Open Market Paper (holdings up SAAR $413bn) and Mortgages (holdings up SAAR $688bn). On the Liability side, “Net Interbank Liabilities” expanded at an unprecedented SAAR $897bn, of which SAAR $515bn was borrowed from the Fed. Elsewhere, the GSEs expanded assets SAAR $85bn (about 2.5% annualized), and Agency MBS surged SAAR $508bn (11.2% annualized). Notably, Total Bank Assets were up $1.385 TN, or 12.7%, over the past four quarters.
The dollar was clobbered after Wednesday’s bold “employ all available tools” pronouncement from the Federal Reserve. The way I see it, the Fed Board sent a direct message to the markets that it is resolved to do absolutely whatever is required to ensure sufficient system Credit will be forthcoming – a quantity that for our purposes is in the, say, $2.0 TN annual range. The dilemma for the Fed (and markets) is that while such an enormous amount of Credit would do little more than somewhat steady our maladjusted “Bubble Economy,” it would at the same time perpetuate the massive flow of dollar finance out to the global financial system. In short, the Fed’s determination to reflate ensures continued Monetary Disorder. And I would further argue that Ongoing Monetary Disorder – and associated corruption to various market pricing mechanisms – will impede system adjustment and extend the lengths of U.S. and global downturns and restructuring periods.
During Q3, Rest of World (ROW) accumulated U.S. financial assets at SAAR $816bn. Over the past year, ROW holdings increased a staggering $1.224 TN to $16.772 TN. And it is this nearly $17 Trillion number that I use in my mind as a rough proxy for what I refer to as the “Global Pool of Speculative Finance” – the source of unwieldy financial flows that continue to wreak bloody havoc on global markets and market pricing mechanisms. Over just the past 12 quarters, ROW holdings ballooned more than 50% - and they're still growing rapidly.
It is also worth nothing that ROW Treasury holdings expanded SAAR $819bn during the quarter and were up $674bn, or 30%, over the past year to $2.913 TN. Ominously, ROW reduced holdings of U.S. Credit Market Instruments fell SAAR $547bn during Q3, with Commercial Paper down SAAR $273bn and Bonds down SAAR $291bn. Holdings of Agency Securities declined SAAR $241bn, reducing the one-year increase to $246bn. ROW holdings of “Security Repurchase Agreements” contracted SAAR $368bn during Q3, with a one-year drop of $254bn (22%). We continue to witness the astounding market extremes fostered by ROW risk aversion (zero T-bill yields vs. hopeless illiquidity in many risk markets). Or stated differently, the attribute of "moneyness" today applies only to a narrow scope of top tier U.S. financial claims.