Federal Reserve Q4 2008 Z.1 “flow of funds” report.
The Federal Reserve’s Z.1 “Flow of Funds” reports are no less fascinating in today’s Post-Bubble landscape. The basic thrust of my Credit Bubble analysis these days is that the highly maladjusted U.S. (finance and “services-”driven) Bubble Economy requires in the neighborhood of $2.0 TN of annual Credit growth to hold implosion at bay. Recent dramatic financial and economic tumult – especially during the fourth quarter – supports this view. But it is, at the same time, important to differentiate today’s economic backdrop from the dynamics that fomented financial and economic collapse throughout the emerging markets during the nineties and earlier this decade (i.e. Mexico, SE Asia, Russia, Brazil, Argentina, etc.). The U.S. economy is in severe crisis, but it is not today collapsing. We are not in another Great Depression. We are not yet witnessing the worst-case scenario.
The “Flow of Funds” illuminates why the collapse of the Greatest Credit Bubble in history has not yet translated into one of the greater economic collapses. Despite financial panic and the freezing up of Credit markets, Total Non-Financial Credit expanded at a 6.3% annualized rate during the fourth quarter. While down from Q3’s 8.1% pace, I would argue that 6% plus Credit expansion was about the minimum required to forestall systemic implosion. Importantly, this feat was achieved by the federal government expanding borrowings at a 37% annualized rate.
Some would argue that this massive federal Credit expansion has had minimal impact. They would point to moribund markets for housing and autos, the steep rise in unemployment, and the sharp economic slowdown. Sure enough, Household Mortgage Debt contracted at a 1.6% rate during the quarter, with Household (non-mortgage) Credit sinking at a 3.2% pace. And Corporate debt growth, having expanded at a double-digit rate during the first half of 2007, slowed markedly to 1.2%. Yet, despite collapsing markets for private-sector Credit, Total (economy-wide) Compensation for the 4th quarter was actually up 1.9% y-o-y to a record (annualized) $8.096 TN. For the year, National Income was up 1.5% to a record $12.453 TN, with Total Compensation up 3.1% to $8.058 TN. How was it possible for such a deeply impaired Credit system to sustain such an inflated level of National Income in the face of a housing and asset market collapse?
Remarkably, Domestic Financial Sector Debt Growth accelerated from Q3’s 6.8% pace to a 7.2% rate of expansion. On a Seasonally-Adjusted and Annualized Rate (SAAR) basis, Total Financial Sector borrowings jumped to $1.222 TN during the quarter. This was in the face of the Asset-Backed Securities (ABS) market contracting SAAR $616bn. This critical contraction in private sector Credit was, however, largely offset by combined GSE debt and MBS growth of SAAR $569bn. Bank Commercial Loans expanded SAAR $858bn, while Open Market Paper increased SAAR $341bn.
For all of 2008, Treasury securities outstanding increased an unprecedented $1.239 TN, or 24.3%. Meanwhile, Agency securities (GSE debt and MBS) jumped $716bn, or 9.6%. Combined federal and quasi-federal securities outstanding ballooned an incredible $1.955 Trillion in just one year. For comparison, Treasury and the Agencies combined to increase debt securities $1.146 TN during 2007, $514bn in 2006 and $390bn in 2005. This ramp up of government Credit growth is outdoing even the historic surge in mortgage Credit during the Mortgage Finance Bubble years.
Federal debt growth offset a contraction in several key sectors of private-sector Credit intermediation/creation. Total Mortgage Debt (TMD) expanded only $78bn during 2008. TMD Growth reached about $1.4 TN annually during ’05 and ’06 and averaged $1.177 TN annually during the six Bubble Years 2002 through 2007. For comparison, TMD expanded on averaged $270bn annually during the nineties. With the Mortgage Finance Bubble now burst, the ABS (including Wall Street’s “private-label” mortgage-backed securities) market is in disarray. Through the first eight years of the decade, the ABS market ballooned 240% to $4.50 TN. Annual growth peaked in 2006 at $912bn. In an historic reversal of fortunes, the ABS market contracted SAAR $616bn during the fourth quarter and declined $442bn for all of 2008.
Nowhere was the implosion of “Wall Street finance” more apparent than it was with the Securities Broker/Dealers. Broker/Dealer assets contracted nominal (non-annualized!) $785bn during the final three months of the year, although much of this was likely reclassification of Lehman and Merrill assets. It is worth noting that Miscellaneous Broker/Dealer Assets contracted SAAR $1.726 TN, while Treasury holdings expanded SAAR $774bn. For the year, Broker/Dealer assets were down $875bn, or 28%, to $2.217 TN.
With the “moneyness” of Wall Street finance having disappeared, the (offsetting) issuance of government “money” has amounted to nothing less than a historic explosion of debt issuance. For the year, Agency debt expanded 9.0% to $3.459 TN. GSE MBS grew 11.2% to $4.965 TN. Over the past two years, Agency debt expanded $585bn, or 20%, and GSE MBS ballooned an unprecedented $1.128 TN, or 29%. Combined with Treasury’s two-year debt issuance of $1.477 TN, one tabulates incredible 2-year federal government (“money”) issuance of $3.20 TN (28%). And this already incredible debt growth is now poised to really accelerate. At the Federal Reserve, Total Assets expanded an unmatched $729bn during the quarter to $2.270 TN, with one-year growth of 139%. Washington should feel quite fortunate that the markets continue to accommodate such alarming debt expansion at such meager little interest rates. There is no mystery why the Chinese and our other creditors are increasingly disturbed by our government’s borrowing habits.
The Unfolding Government Finance Bubble has been somewhat able to mitigate the implosion of Wall Street finance. But the greater dilemma is two-fold: On the one hand, the distorted economy requires massive ongoing Credit creation. Here, government finance can and has taken up the slack. However, the nature of spending created by the inflation of government obligations will remain quite dissimilar to that spurred by the runaway inflation of Wall Street finance. The flow of finance has been permanently altered. There will be no rejuvenating the previous asset inflation and consumption booms. Indeed, the Household (and non-profits) balance sheet rather starkly illustrates the nature of the problem.
During the fourth quarter, Total Household Assets dropped a record $5.419 TN, or 31% annualized, to $65.719 TN. Wow… Financial Asset values sank a record $4.537 TN (to $40.814 TN), and Real Estate dropped a record $871bn (to $20.512 TN). Little wonder auto purchases and retail spending went into a tailspin, as Household Net Worth shrank a record $5.110 TN during the quarter (to $51.477 TN). For the year, Household Assets collapsed $11.30 TN (14.7%), while Liabilities were little changed at $14.242 TN. For the year, $11.213 TN of Household Net Worth ("perceived financial wealth") disappeared. This compares to the average annual increase in Household Net Worth of $5.444 TN during the period 2003 through 2006. The Household Balance Sheet continues to offer invaluable insight on the workings of a Bubble Economy.
Rest of World (ROW) data document a quarter of mayhem in global finance. ROW holdings of U.S. financial assets increased SAAR $738bn (to $16.897 TN), down from Q3’s $1.010 TN and Q4 2007’s $804bn. But there were some abrupt shifts in the composition of holdings. Net Interbank Assets jumped SAAR $1.344 TN, while Securities Repos dropped SAAR $1.273 TN. Treasury holdings surged SAAR $1.094 TN (to $3.187 TN), while Agency and GSE MBS holdings dropped SAAR $1.006 TN (to $1.331 TN). Miscellaneous Assets expanded SAAR $407bn during the quarter to $5.409 TN. For the year, ROW holdings of U.S. assets increased $857bn, down from 2007’s $2.081 TN increase – to the slowest rate of growth in more than a decade.
Chaos on Wall Street has thrown an additional layer of complexity upon an already challenging Banking sector “flow of funds” analysis. I’m forced to keep it simple. Banking system assets were up $1.033 TN (nominal) during the quarter to $13.417 TN, with 2008 growth of $2.225 TN (20%). Bank Credit expanded 15.2% for the year to $9.680 TN, while Miscellaneous Assets jumped 65% to $2.858 TN. On the Liability side, Total Deposits were up 8.9% for the year to $7.180 TN. Miscellaneous Liabilities jumped 62% to $2.933 TN.
The Fed’s and Treasury’s move to bolster the money fund complex was critical to averting financial collapse. Retaining their “moneyness,” Money Fund assets expanded at a 45% rate during the fourth quarter to a record $3.757 TN. For the year, Money Fund assets jumped $724bn, or 24%.
Elsewhere, the enigmatic Funding Corps had a huge quarter and year. Funding Corp assets increased $1.057 TN during the quarter to $3.571 TN, with total 2008 growth of $1.735 TN. Credit Union assets expanded 7.3% last year to $814bn, while Finance Companies were about unchanged at $1.912 TN. REITs contracted about 10% in 2008 to $523bn. Savings Institution assets fell 16% to $1.526 TN. Life Insurance assets declined 6% last year to $4.411 TN.