Federal Reserve Q2 2010 Z.1 “flow of funds” report.
From the Fed’s Q2 2010 Z.1 – “Flow of Funds,” Total Non-financial Credit growth expanded at a respectable 4.8% pace. This compares to Q1’s 4.5%, and it was actually the strongest rate of growth since Q4 2008’s 5.7%. The bad news is that federal government Credit continues to completely dominate. During Q2, federal borrowings expanded at a 24.4% rate, up from Q1’s 20.5% and Q4 ‘09’s 11.9%. With Household Mortgage Credit contracting at a 2.3% rate (down from Q1’s 4.3%), Total Household Debt also declined at a 2.3% pace during the period. Corporate debt grew at a 3.8% rate, down from Q1’s 5.8%. State & Local borrowings contracted at a 1.3% pace, a notable reversal from Q1’s 5.7% rate of expansion.
In nominal dollars, Total (non-financial and financial) outstanding System Credit was little changed during the quarter at $52.055 TN. Total Credit was down $455bn, or 0.9% from a year earlier. And from the peak set during Q1 2009, Total System Credit has declined $694bn, or 1.3%. It’s worth recalling that Total Credit began the decade at $25.389 TN. Total Credit ended the second quarter at 357% of GDP, after beginning the decade at about 260%. While it can be said that the household sector is somewhat “de-leveraging,” the same is not true of the system overall.
In Seasonally-Adjusted and Annualized Rates (SAAR), Total Non-financial borrowings increased $1.671 TN during the quarter. This was up from Q1’s $1.563 TN, to the strongest Credit growth since Q4 2008’s $1.90 TN. Federal borrowings increased to SAAR $2.00 TN, up from Q1’s $1.60 TN and second only to Q4 2008’s $2.10 TN. Total Household debt contracted SAAR $309bn during the quarter, while Corporate debt expanded SAAR $278bn. State & Local borrowings contracted SAAR $32bn.
The massive inflation of government Credit continues to coincide with the “de-Bubbling” of the U.S. financial sector. Financial sector borrowings contracted SAAR $1.070 TN, or a pace of negative 7.1%. This was, however, the slowest rate of contraction in six quarters. By financial sector category for the quarter, Open Market Paper contracted SAAR $277bn; GSE Issues contracted SAAR $110bn; Corporate Bonds contracted SAAR $482bn; Bank Loans (business) contracted SAAR $83bn; and Other Loans & Advances contracted SAAR $140bn. Expanding during the quarter, Agency MBS increased SAAR $245bn and Mortgages rose SAAR $2.0bn.
Banking sector stagnation ran unabated. Total Bank Assets declined slightly during Q2 to $14.411 TN. At the same time, Bank Credit contracted at a 5.6% pace during the quarter to $9.394 TN. Bank Credit was down 1.3% from a year ago. Bank (business) Loans declined at a 6.7% annualized rate and were down 14.4% y-o-y. Mortgage loans contracted at a 5.7% pace (down 4.9% y-o-y), as write-downs continue. Meanwhile, Bank holdings of government debt were up 12.1% y-o-y to $1.507 TN. And Miscellaneous Bank Assets jumped (nominal) $177bn during the quarter to $4.069 TN (up 0.2% y-o-y).
Broker/Dealer assets dropped (nominal) $120bn during the quarter to $1.966 TN, with assets down 2.3% y-o-y. Elsewhere, Finance Company assets declined at a 5.4% pace (down 7.5% y-o-y). Savings Institution assets fell at a 5.5% rate to $1.245 TN, with a y-o-y decline of 10.9%. Credit Unions bucked the trend, with 3.2% quarterly and 3.9% y-o-y growth - to $903bn. REIT liabilities expanded at a 1.1% rate to $488bn (down 0.2% y-o-y).
The ongoing financial sector contraction has not been an indication of a systemic downward debt spiral. There have been ongoing write-downs of problem mortgages and loans, while lending has remained weak generally. Yet it is important to also recognize that the massive expansion of government debt has been playing an integral role in spurring financial sector contraction. During a private-sector Credit boom, financial sector liabilities grow as part of the debt intermediation process. Bank Credit expands as loans are made and deposits are created. MBS and ABS expand as mortgage and consumer Credit are intermediated through the securitization marketplace. The expansion and financial sector intermediation of private-sector Credit would increase a wide range of the sector’s liabilities and assets.
The ballooning of the government’s balance sheets (expansion in public Credit) has altogether different effects on financial sector assets and liabilities. Importantly, there is little need to intermediate government borrowings. The government issues its own debt and sells it directly into the marketplace (in contrast to mortgage Credit extended during the boom).
Today’s government finance Bubble also feeds enormous amounts of income and “cash flow” throughout the household, corporate and financial sectors. This would tend to support so-called “de-leveraging” (debt repayment) for households and corporations, in the process reducing the need for financial sector risk intermediation. This helps to explain the stagnation in “money” supply and Bank Credit – and why these traditional indicators of system “liquidity” have lost much of their relevance.
It is worth noting that National Income ended Q2 up 5.3% y-o-y at $12.767 TN. This was the strongest 12-month growth since Q1 2008. National Income has almost recovered back to its Q3 2008 high of $12.781 TN. Total Compensation enjoyed its strongest quarterly growth in two years. While employment and overall economic performance have badly lagged during this recovery, there should be no disputing that the massive issuance of government debt has worked wonders in stabilizing incomes and overall expenditures (at inflated Bubble levels).
The media jumped on the $1.521 TN quarterly decline in Household Net Worth. Most of this decline was due to the stock market drop. It should be noted that equities were near their low for the year as of June 30, and have since rallied about 10%. Despite weaker stocks, Household Net Worth was up 6.3% y-o-y to $53.50 TN. This was up from the Q1 2009 low of $48.80 TN low, but still significantly below the Q4 2007 high of $64.24 TN. Household Net Worth is today probably near the early 2006 level. Total Household Assets ended Q2 at $67.413 TN (up 4.6% y-o-y), with Liabilities at $13.913 TN (down 1.5% y-o-y).
Rest of World (ROW) holdings of U.S. financial assets expanded SAAR $972bn during the quarter to $16.255 TN. Keep in mind that this number began the 1990s at about $1.9 TN and started this decade at $6.1 TN. For the quarter, ROW increased holdings of Treasurys SAAR $709bn, with Agency securities up SAAR $147bn. ROW reduced holdings in “repos” (SAAR $359bn) and corporate bonds (SAAR $120bn). ROW holdings of U.S. financial assets were up $1.436 TN y-o-y, or 9.7%. Treasury holdings were up 12.1% y-o-y to $4.014 TN. Corporate bond holdings were up $375bn y-o-y to $2.278 TN.
On a year-over-year basis, Federal government expenditures were up 5.0% to $3.704 TN (expenditures up 30% from three years ago). Over the past nine quarters, federal expenditures have jumped from about 21% to 25% of GDP. Federal receipts were up 8.5% y-o-y during Q2 to $2.378 TN, or 16.3% of GDP. During the past nine quarters, receipts have fallen from about 19% of GDP. State & Local receipts grew 6.4% y-o-y to $2.113 TN, while State & Local expenditures were up 3.5% y-o-y to $2.092 TN. Total government expenditures during the quarter jumped to 40% of GDP.
The Government Finance Bubble thesis holds that government debt is the latest - and greatest - episode of Hyman Minsky’s “Ponzi Finance.” During Q2, the markets accommodated a $2.0 Trillion annualized pace of federal debt growth. In just eight quarters, federal government debt expanded $3.610 TN, or 54%, to $10.308 TN. In a short 24 months, federal debt has jumped from 46% to 71% of GDP. And as long as the markets allow such unprecedented issuance of non-productive Credit at historically low yields, it’s quite possible that household incomes, corporate earnings, the general economy, and the securities markets might appear ok. Heck, Washington seems awfully determined to resuscitate asset prices. But we don’t have to look back too many quarters for a stark reminder of the nature of Ponzi Dynamics and Fragilities.