Federal Reserve Q2 2009 Z.1 “flow of funds” report.
For the quarter, Non-Financial Credit growth accelerated to 4.9% annualized, up from Q1’s 4.1% and compared to Q2 2008’s 3.3%. In nominal seasonally-adjusted and annualized rate (SAAR) terms, Non-Financial debt expanded $1.646 TN. This was up strongly from Q1’s $1.371 TN SAAR, but still below the $2.0 TN or so I deem necessary to (at least temporarily) stabilize the system. Keep in mind that the economy remained quite weak for much of Q2. I would expect Q3 Credit growth in the neighborhood of $2.0 TN annualized. For perspective, Non-Financial Credit expanded $865bn in 2000, $1.152 TN in 2001, $1.413 TN in 2002, $1.671 TN in 2003, $1.997 TN in 2004, $2.329 TN in 2005, $2.400 TN in 2006, $2.539 TN in 2007 and $1.888 TN in 2008.
And while the recovery in Credit is on the surface encouraging, the composition of this growth is disconcerting. For the quarter, Household debt contracted at a 1.7% rate, with Home Mortgage and Consumer Debt down 1.4% and 6.5% annualized – both worse than Q1 (declines of 0.1% and 3.7%). Corporate borrowings expanded at only 1.0% annualized, down from Q1’s 2.1% and compared to 6.7% back in Q2 2008. Private sector Credit remains stuck in the muck.
Meanwhile, State & Local debt growth accelerated to 8.3% annualized, up from Q1’s 4.9% and Q2 2008’s 0.9%. State & Local governments expanded borrowings $187bn SAAR - a resurgence back to the peak borrowing level from 2007 ($186bn). Federal borrowings expanded at a blistering 28.2% pace, up from Q1’s 22.6% and compared to Q2 2008’s 5.9%. Federal borrowing increased to $1.895 TN SAAR during the quarter. State & Local and Federal combined debt growth reached $2.082 TN SAAR, significantly larger than the total system Non-Financial debt growth of $1.646 TN SAAR (with Household Credit and Mortgage debt contracting).
Over the past four quarters, Non-Financial Credit expanded $1.959 TN, or 6.1%, to $34.320 TN. This was no small amount of debt growth. Treasury borrowings increased $1.893 TN over the past year to $7.143 TN. And during this period Federal Reserve assets ballooned $1.111 TN, or 117%, to $2.063 TN. It is incredible to watch the emerging Government Finance Bubble take such command of U.S. Credit.
On an SAAR basis, the Federal Reserve increased Agency- and GSE-Backed Securities $1.088 TN during Q2 (nominal $272bn). In nominal dollars, Fed holdings of Agency (mostly MBS) securities increased from $20bn at year-end to $559bn by the end of Q2. And keep in mind that Home Mortgage debt actually contracted $53bn during this period (to $10.951 TN).
There is a perception that the Fed’s agency MBS purchase program is specifically targeting stabilization of the conventional mortgage market. Yet, examining the data, one can see that the private-label MBS marketplace is perhaps the greater beneficiary of Federal Reserve largess. For the quarter, Issuers of Asset-Backed Securities (chiefly pools of private-label/non-GSE mortgages) contracted $499bn SAAR, this after a $614bn SAAR contraction in Q1. But this was offset by an increase in GSE MBS of $556bn SAAR in Q2 and $304bn SAAR in Q1.
So, the Fed is amassing quite a stockpile of “conventional” GSE MBS, but often these are “private-label” mortgages recently “refinanced” into GSE securities. And as the Fed buys the new GSE MBS, newly created funds become available to flow back to reliquefy the formerly illiquid ABS marketplace (along with agencies, Treasuries, corporates, and equities). To be sure, placing essentially federal government backing upon previously “private-label” mortgages dramatically changes the market’s perception of these securities’ worth (“moneyness”) – especially with fed funds pegged for an extended period at near zero and the Fed in the midst of a $25bn weekly purchase program in order to fulfill it commitment to purchase $1.25 TN of mortgage securities.
During the quarter, outstanding GSE MBS expanded at a 10.4% rate to $5.173 TN. GSE MBS increased $414bn, or 8.7%, over the past year and $1.098 TN, or 26.9%, over two years. During Q2, the ABS market contracted at a 12.2% rate to $3.817 TN. ABS declined $525bn over the past year, or 12.1%, and $673bn, or 15%, over two years. Here we see confirmation that nationalization of mortgage Credit runs unabated. Not only is the vast majority of new mortgage Credit this year government-backed, Washington guarantees are being slapped on hundreds of billions of existing “nonconventional” mortgages. This intrusion and transfer of (Credit and interest rate) risk has terrible long-term ramifications. Although in the near-term this mechanism provides a powerful stabilizing force for both the Credit system and real economy.
Bank Credit contracted at a 1.4% pace during the quarter to $9.523 TN. Similar to the money supply numbers, I have tended this year to deemphasize private lending data in my analysis. After all, how much can we expect to discern from traditional Credit-related metrics when policymakers are issuing Trillions of Treasuries/agencies Credit and the Fed is monetizing a Trillion or so? It is, however, worth noting that Bank holdings of Government Securities expanded at a 16.2% pace during the quarter to $941bn. Mortgages increased at a respectable 4.6% clip to $3.899 TN. Business loans contracted at a notable 17.8% pace (to $2.031TN), although this may be somewhat explained by the thawing of the corporate debt securities marketplace (companies issuing debt to repay bank borrowings).
On the bank Liability side, total Deposits expanded at a 5.2% rate during the quarter to $7.278 TN (up 7.8% y-o-y). Credit Market borrowings were about flat at $1.720 TN. Fed Funds & Repo expanded ($133bn) for the first time in eight quarters (to $596bn). Meanwhile, Miscellaneous Liabilities contracted at a 24% rate to $2.468 TN.
Posting the strongest growth since Q2 2007, Securities Broker/Dealer assets expanded at a 14.5% pace to $2.00 TN. Broker Dealer assets increased $514bn SAAR during the quarter, although most of this is explained by an increase in Treasuries holdings (up $404bn SAAR). With the Fed’s massive MBS buying program in mind, it’s not surprising to see Broker/Dealer holdings of Agency and MBS declining $179bn SAAR. It is worth noting that, on the Liability side, Security Repos expanded $224bn SAAR, the first increase in repos since Q1 2008. “Other” Miscellaneous Liabilities increased $309bn SAAR.
Examining the miscellaneous categories, Finance Companies contracted 8.6% annualized to $1.777 TN (down 7.9% y-o-y). Credit Unions expanded 9.9% annualized to $877bn (up 9.1% y-o-y). REITs increased 13.3% annualized to $260bn (down 13.5% y-o-y). Money Market contracted at a 16.5% rate during Q2 to $3.584 TN, cutting y-o-y growth to 8.0%. Life Insurance assets grew at an 11.9% pace to $4.552 TN (down 6.6% y-o-y).
Rest of World holdings were down a rather insignificant $134bn SAAR to $14.200 TN. There were, however, some meaningful changes in the composition of foreign holdings of U.S. assets. Net Interbank Assets contracted $692bn SAAR, while Official Treasury holdings jumped $494bn SAAR. U.S. Corporate Bond holdings declined $110bn SAAR, while Miscellaneous Assets expanded $227bn SAAR.
In total, Rest of World purchased $403bn SAAR of Treasuries during Q2, about a quarter of total issuance ($1.896 TN SAAR). Who were the other major purchasers? The Fed monetized $647bn SAAR, the Household Sector bought $343bn SAAR, and Broker/Dealers accumulated $404bn. And while it is positive that American households are buying Treasuries and saving more, this does not change the fact that this so called “savings” was bolstered by income effects from massive government spending increases.
Examining income data, National Income stabilized during the quarter at $12.162 TN. After declining $347bn annualized during Q4 2008 and $225bn annualized during Q1, National Income slipped only $47bn annualized during the quarter. National Income was down 4.0% y-o-y. Total Compensation was down 3.8% y-o-y to $7.726 TN. National Income and Compensation began the decade at $8.358 TN and $5.354 TN. It is my view that, at this point, only massive federal deficits and government intrusions will stabilize system incomes at today’s highly inflated levels.
Federal Q2 Receipts were down 6.6% y-o-y to $2.215 TN SAAR, while Federal Expenditures surged 35.9% to $3.510 TN SAAR. For comparison, federal expenditures were $2.393 TN in 2004, $2.573 TN in 2005, $2.728 TN in 2006, $2.897 TN in 2007 and $3.118 TN in 2008. So current spending levels are running almost 50% above where they were five years ago. Second quarter State & Local receipts were just slightly ahead of the year ago level to $2.004 TN. Spending was slightly down from a year earlier to $2.014 TN.
The media was quick to pick up on the quarter’s $2.0 TN increase in Household Net Worth. For the bad news, Net Worth was still down $7.438 TN over the past year. With Household Liabilities essentially flat (down 1.0% annualized) at about $14.10 TN, changes in Household Assets dictate the increase/decrease in Net Worth. For the quarter, assets were up $1.964 TN, or 12.0%, to $67.208 TN. This jump places asset values back to mid-2005 levels. Real Estate holdings actually rose $157bn (nominal) to $20.026 TN, the first increase in 10 quarters. Yet, reflation’s real impact was felt in the $1.777 TN (17.5%) jump in household holdings of Financial Assets. Over the past year, the value of Real Estate declined $1.759 TN and Financial Assets dropped $6.043 TN. It is worth noting that, despite the crisis, Household Net Worth was up about a third in seven years.