Federal Reserve Q3 2012 Z.1 “flow of funds” report.
For the quarter, the growth in Total Non-Financial Debt (TNFD) slowed to a rate of 2.4%, less than half the 5.1% pace from Q2 2012, but close to the 2.5% rate from Q3 2011. After expanding at a 10.9% rate in Q2, Federal debt growth slowed sharply to 6.2%. State & Local borrowings about flat-lined (negative 0.1%), a marked slowdown from Q2’s 3.1% rate of expansion. Interestingly, after expanding at a 1.2% rate in Q2 (strongest since Q1 ’08), Total Household debt contracted 2.0% annualized during Q3. Home mortgage debt contracted at a 3.0% rate (vs. Q2’s 2.1% contraction), while non-mortgage Household debt growth slowed to 4.3% (from Q2’s 6.5%, the strongest since Q3 2007’s 7.6%). Corporate debt expanded at a robust 6.2% pace during Q3, little changed from Q2 (6.3%).
In seasonally-adjusted and annualized rates (SAAR), Total Non-Financial Debt (TNFD) growth slowed to $952bn, down from Q2’s $1.971 TN. This places average growth for the first 9 months of the year at SAAR $1.564 TN, which compares to 2011’s $1.325 TN, 2010’s $1.438 TN, 2009’s $1.059 TN, and 2008’s $1.891 TN. Keep in mind that annual TNFD growth was in the neighborhood of $650bn back in the mid-nineties. In the first nine months of 2012, Total Non-Financial Debt expanded a nominal (non-annualized) $1.163 TN. By sector, Federal borrowings increased $825bn (71% of total) in nine months, Total Business $374bn (32%), State & Local $18bn (2%), and Total Household negative $58bn (negative 5%). The federal government’s unprecedented dominance of system Credit is now well into its fifth year.
I’m going to somewhat cut to the chase and jump to the Household Balance Sheet. Typically, a sharp deceleration in Credit growth would be associated with general Credit market weakness. And early in Q3 there was some Europe-related market stress and modest financial conditions tightening. This was, however, met with overwhelming policy measures in Europe (“whatever it takes”), with the Fed (“QE infinity”) and elsewhere. The end result was a period of significantly loosened finance, higher asset prices and, importantly, a policy-induced inflation in Household Net Worth.
For the quarter, Household sector Assets jumped $1.711 Trillion to $78.204 TN. Over the past year, Household Assets have inflated $6.073 TN, or fully 39% of GDP, to now having almost recovered back to late-2007 record highs. And with Household Liabilities contracting slightly to $13.436 TN, Household Net Worth gained $1.722 TN during the quarter to a record $64.769 TN. Household Net Worth was up $6.103 TN, or 10.4%, over the past year and $10.084 TN, or 18.4%, over two years. To explain the strength in retail sales over the past couple years, one need not venture much beyond the extraordinary $10 TN increase in perceived Household Net Worth. It is also worth noting that 82% of this gain can be explained by the rise in Household holdings of Financial Assets.
The profound role fiscal and monetary stimulus has had on bolstering incomes, spending, corporate earnings and asset prices is fundamental to the “government finance Bubble” thesis. Total National Income expanded at a 3.9% pace during the quarter to a record SAAR $13.912 TN. Total Compensation increased at a 3.0% pace to a record SAAR $8.568 TN, with Total Comp up $250bn over the previous year, or 3.0%. Over two years, Total Compensation jumped $546bn, or 6.8%. For comparison, Total Comp expanded about $820bn during the booming two-year period 2005-2006.
Driving the two-year inflation in Household Net Worth and Incomes was a $2.463 TN jump in Federal Liabilities, to a record $13.111 TN. Federal Liabilities inflated 23.1% in two years, with a 17-quarter increase of $6.614 TN, or 96%. Outstanding Treasury Debt was up $1.153 TN over the past year (11.4%), $2.262 TN over two-years (25.1%), and $6.005 TN over 17 quarters (114.4%). Federal Debt-to-GDP increased to 83%, yet this of course excludes most of our government’s massive contingent liabilities. A Wall Street Journal op-ed from last week (Chris Cox and Bill Archer) noted “actual liabilities of the federal government – including Social Security, Medicare, and federal employees’ retirement benefits – already exceed $86.8 trillion, or 550% of GDP.”
At SAAR $3.757 TN, federal government expenditures were up 0.4% from Q3 2011, and federal receipts were 6.8% higher to SAAR $2.683 TN. Going back five years (to Q3 2007), federal expenditures have inflated $847bn, or 29%, while receipts have gained only $18bn, or 1%.
Credit Bubbles are at their core about an unsustainable expansion of Credit - the inflation of financial claims spurred by market misperceptions and associated mispricing. During the Bubble, the rapid expansion of Credit is self-reinforcing specifically because financial profligacy will ensure that most “fundamentals” (i.e. corporate profits, GDP, stock prices, etc.) appear supportive. And, importantly, major Credit Bubbles are invariably created through heightened government intervention in “money,” the markets and throughout the real economy. The perception that Treasury, Congress and the Fed would never tolerate a housing bust was the critical fallacy that ensured a historic boom and bust cycle. In somewhat different dynamics than those of the mortgage finance Bubble period, extraordinary fiscal and monetary measures have convinced the marketplace that the historic confluence of massive issuance of (non-productive government) debt and record high debt security prices is both sensible and sustainable. Once again, market price distortions are driven by the perception of all-powerful intervention, in this case that the Federal Reserve and foreign central banks will indefinitely accumulate this debt at record high prices.
For Q3 2012, Rest of World (ROW) accumulated U.S. Financial Assets at SAAR $625bn to a record $19.388 TN. In what would not appear a great vote of confidence, demand was predominantly for low-yielding government debt. Treasury holdings expanded SAAR $624bn (to $5.445 TN). Agency-GSE-backed securities increased SAAR $21bn ($1.067 TN), while Corporate Bonds declined SAAR $4bn ($2.444 TN) and Loans to Corporate Business fell SAAR $29bn ($164bn). Holdings of U.S. Equities increased SAAR $186bn ($3.471 TN), Mutual Fund Shares increased SAAR $44bn ($646bn) and Foreign Direct Investment grew SAAR $86bn ($2.998 TN). Other Miscellaneous Assets dropped SAAR $354bn ($1.539 TN).
The foreign accumulation of our nation’s Financial Assets has been integral to sustaining the great Credit Bubble. Foreign holdings of U.S. financial assets began the ‘90s at about $1.9 TN before ending the decade at $5.776 TN. Balances swelled incredibly during the mortgage and government finance Bubbles. ROW holdings more than doubled between 2002 and 2007, expanding $8.673 TN during the mortgage Bubble period to end 2007 at $16.038 TN. ROW holdings dropped almost $800bn during 2008 and expanded only $567bn in 2009. Net annual purchases then swelled to $1.599 TN in 2010 and $1.396 TN in 2011. Markets today retain faith that foreign central banks and others will maintain their insatiable appetite for U.S. financial claims – no matter the quantity or quality of issuance.
Treasury and U.S. fixed-income prices have certainly been inflated by the perception of a Federal Reserve market backstop. While the Fed’s balance sheet contracted $46bn during the quarter to $2.838 TN, asset growth has returned during Q4 – and the Fed is apparently determined to commence another aggressive balance sheet inflation cycle beginning in January (talk of $85bn monthly purchases). Perhaps the sharp Q3 slowdown in system Credit expansion contributed to the latest bout of acute dovishness afflicting our central bankers. Maybe they examined recent mortgage debt trends and fretted, “How on earth can we ever orchestrate a handoff of the Credit baton from the public sector back to the private sector if mortgage Credit is not expanding! Yields must be pushed lower still!”
It is worth noting that the Fed’s balance sheet closed out the nineties at $697bn, and then ended 2004 at $841bn, 2006 at $908bn, 2007 at $951bn, 2008 at $2.271 TN, 2009 at $2.267 TN, 2010 at $2.453 TN and 2011 at $2.947 TN. 2013 $3.500 TN? I couldn’t suppress a chuckle after reading a Friday Bloomberg headline: “Ballooning Balance Sheet Brings Fed Closer to Exit-Plan Overhaul.” Well, that’s one way of looking at it.
I’ve essentially ignored the (stagnant) banking system in my “flow of funds” analyses over recent quarters. Total Bank Assets grew only $66bn during Q3 to $14.762 TN – and were up only $197bn (1.4%) over the past year. Yet I would be remiss for not noting the 9.7% y-o-y increase in business loans (to $2.174 TN) or the 8.3% y-o-y increase in government securities holdings (to $2.231 TN). Meanwhile, Corporate Bond holdings were down 4.1% y-o-y (to $776bn), mortgage loans contracted 2.0% (to $4.334 TN) and Misc. Assets fell 11.0% y-o-y (to $1.267 TN). On the Bank Liability side, Total Deposits were up $495bn, or 4.9%, y-o-y to $10.532 TN.
With federal government liabilities now locked in an historic inflationary cycle, there’s at this point a significantly reduced need for the traditional workings of the U.S. financial sector. The vast majority of system Credit growth remains governmental. In stark contrast to the mortgage finance Bubble, this Credit for the most part need not be intermediated (transformed from risky Credit to perceived safe instruments) through the banking system, or through asset-backed (ABS) and mortgage-backed (MBS) securitization. It is also worth noting that, at $7.544 TN, total GSE Securities (debt and MBS) were little changed during the quarter and declined only 0.5% over the past year. And while Total Home Mortgage Credit has contracted $660bn over the past two years, GSE securities have declined only $54bn. Despite talk of “winding down” Fannie and Freddie, total GSE securities are about where they were in early 2008. It is worth noting that GSE securities began year-2000 at $1.723 TN.
Monitoring the financial sector for signs of rejuvenation remains less than fruitful. Finance Companies were stagnant for the quarter and year. Securities Broker/Dealer assets were down slightly during the quarter (assets up $70bn, or 3.5% y-o-y, to $2.051 TN). The ABS market continues to contract (down $216bn y-o-y to $1.824 TN). Money Market Funds expanded $39bn during the quarter to $2.507 TN, reducing the year-over-year contraction to $170bn. Fed Funds and Repo increased $32bn y-o-y, or 2.9%, to $1.134 TN. Funding Corps increased $70bn y-o-y, or 3.6%, to $2.256 TN. Credit Union Assets did see year-over-year growth of 5.5% to $897bn. Real Estate Investment Trust (REITs) Liabilities jumped $67bn to $792bn, with one-year growth of $172bn, or 28%.
From my analytical perspective, the SAAR $299bn contraction of Home Mortgage Credit was the biggest surprise for the quarter. This compares to Q2’s $214bn contraction and Q3 2011’s $200bn decline. With mortgage borrowing costs having taken another leg down to historic lows – and all the talk of an unfolding housing recovery – I was anticipating a return to positive mortgage Credit growth in Q3 or Q4.