Federal Reserve Q3 2010 Z.1 “flow of funds” report.
The rate of total Non-financial debt growth slowed to 4.2% in the third quarter, down from Q2’s 4.7%, yet strong in comparison to Q3 2009’s 2.1%. Similar to the year ago period, federal borrowings slowed markedly during the quarter. After expanding at a 24.4% pace in Q2, federal debt expansion slowed to a still robust 16.0% pace (and it is poised to accelerate again during Q4). Interestingly, state&local debt growth jumped to 5.2% (Build America Bonds?) compared to Q2’s 1.5% contraction. In the private sector, Household debt contracted at a 1.7% pace, down from Q2’s 2.2% decline and Q1’s 2.1%. Corporate borrowings expanded at a 4.5% pace, up from Q2’s 3.7%.
In seasonally adjusted annual rates (SAAR), total Non-financial debt growth slowed to $1.473 TN, down from Q2’s $1.663 TN. I have posited that our ("Bubble economy") maladjusted economic structure requires in the neighborhood of $2.0 TN of non-financial growth to stimulate self-reinforcing growth in asset prices, incomes and employment. But with household mortgage borrowings contracting SAAR $256bn and total corporate borrowings expanding only SAAR $185bn, even massive government debt growth has been insufficient from the total system Credit perspective. During Q3, federal borrowings expanded SAAR $1.396 TN (down from Q2’s $2.003 TN) and state&local grew SAAR $124bn (up from Q2’s $37bn contraction).
This year will mark the second consecutive year where federal borrowings will have actually expanded more than the growth of total Non-financial borrowings. Nothing similar to this has happened in the post-WWII period. For perspective, even during the deficit-prone 1970s, total federal borrowings were only 16% of total Non-financial debt growth during the decade (the annual high was 1975’s 50.8%). Federal borrowings equaled 22% of total Non-financial debt growth during the eighties (1982 high of 42.9%). The nineties saw total federal borrowings for the decade drop to 14.4% of total Non-financial debt growth (1991 high at 66.8%).
It is worth highlighting that even during the height of the mortgage finance Bubble, the annual expansion of mortgage Credit as a percentage of total Non-financial debt growth did not exceed 64% - although this ratio had about doubled from pre-Bubble levels. Total mortgage debt doubled in the seven years 2001 through 2007 – with mortgage Credit growth accounting for 57% of the expansion in total Non-financial Credit during this period. Such unbalanced flows of finance foment market distortions and economic imbalances. The overwhelming expansion of mortgage Credit certainly set the stage for one tumultuous period in the financial markets and real economy when this source of (unstable) Credit growth abruptly ended (with the bursting of the Bubble).
In just 9 quarters, total federal liabilities have ballooned $4.013 TN, or 60%. After doubling mortgage Credit in less than 7 years, our system is now on track to double federal debt in about four years. Federal expenditures jumped to a record SAAR $3.760 TN during the third quarter, up 6.4% from Q3 2009; up 19% from Q3 2008; and 29% higher than Q3 2007. Federal expenditures increased to 25.5% of GDP during the quarter, up from 20.8% in Q3 2007. During the quarter, combined federal and state&local expenditures reached almost 40% of GDP (vs. 34.4% during Q3 2007).
On the back of massive governmental borrowing and spending, Q3 annualized National Income was up 5.7% y-o-y to a record $12.903 TN, with total Compensation increasing 3.0% y-o-y to $8.032 TN. Despite stubbornly high unemployment, total compensation is now within 0.5% of the all-time high posted during Q3 2008.
The bullish consensus sticks confidently to the view that economic recovery will boost tax receipts and over time reduce the scope of government fiscal shortfalls. It remains my view that only the expansion of private sector Credit will create government net receipts – receipts not offset by government expenditures – that would work to shrink deficits. And it would require a massive increase in private Credit to get anywhere close to a balanced budget situation.
The government sector cannot inflate its way to fiscal health (or even fiscal sanity). And today, in the post-housing mania backdrop, there is no impetus to expanding private sector mortgage borrowings. Housing prices are down and transaction levels are significantly below Bubble levels. Moreover, with deposit and “money” rates at near zero, the Federal Reserve has created strong incentive for savers to use savings to pay down mortgage borrowings. Meanwhile, corporate America is sitting on a huge cash hoard and has little incentive to borrow and invest. For nine quarters now, government finance has completely dominated system Credit creation. There is little indicating that this extraordinary circumstance will change anytime soon.
For the quarter, Total Mortgage debt contracted $115bn, or 3.3% annualized, to $13.947 TN. Household mortgage borrowings shrank at a 2.7% pace (to $10.612 TN) and Commercial mortgages declined at a 6.8% pace (to $2.356 TN). Total Mortgage debt was down 3.5% y-o-y, with a two-year drop of 5.0%.
Financial sector borrowings contracted SAAR $585bn during the quarter, which was actually down sharply from Q1 and Q2 and was the smallest contraction in seven quarters. GSE assets contracted at a 7.5% annualized pace, and the ABS markets shrank at a 14.8% annualized rate. Bucking the trend, agency MBS grew $49bn, or at an 18% pace. Broker/Dealer assets expanded at a 23% pace, although this was only a recovery of Q2’s decline. Broker/Dealer assets were up 1% y-o-y to $2.083 TN (after peaking at $3.244 TN Q1 2008).
Bank Credit actually increased (nominal) $120bn during the quarter, the largest gain in several years. Yet, corporate Bank Loans and Consumer Credit both declined, while Mortgages posted only a small gain. Meanwhile, holdings of Treasury and agency securities jumped $120bn during the quarter (up $261bn y-o-y). Bank Credit was up $296bn year-over-year, of which expansions in Treasury and agency holdings accounted for $261bn. Corporate bank loans were down 6.2% y-o-y and Mortgages were down 3.2%.
Elsewhere, Credit Unions expanded at a 2.2% pace the Q3 (to $907bn). Funding Corps expanded at a 1.0% pace to $2.271 TN, while Fed Funds & Repos were flat ($1.313 TN). Finance Company assets contracted at a 7.2% pace (to $1.613 TN) and Savings Institutions declined at an 8.7% rate (to $1.564 TN). REIT borrowings declined at a 1.9% pace (to $491bn).
Household sector Net Worth increased $1.188 TN during the quarter to $54.891 TN. Inflating net worth and incomes help explain the American household’s spending resurgence. Or another way to look at it: with the existing economic structure and cultural biases, throw trillions of new government-created purchasing power at the U.S. economy and it’s sure to boost consumption. For the quarter, Household Assets increased $1.180 TN to $68.834 TN. Holdings of Financial Assets increased $1.861 TN (17% annualized) to $45.682 TN, while Real Estate declined $698bn to $18.266 TN. Household Liabilities were little changed during the quarter at $13.942 TN. Over the past year, Household Assets were up 2.3%, with Net Worth rising 3.3%.
Rest of World (ROW) holdings of U.S. financial assets jumped during Q3. On a SAAR basis, foreign holders increased holdings $1.335 TN to a record $16.626 TN. This was the largest increase since the financial crisis. The vast majority of this increase (SAAR $1.017 TN) was explained by strong purchases of Treasury securities. In contrast, Foreign Direct Investment is stuck at depressed levels (SAAR $110bn).