Doug Noland: Q2 2004 “Flow of Funds”
The Fed yesterday released the second quarter Z.1 “Flow of Funds” report. Total Credit Market Borrowings (non-financial and financial) increased at a $2.59 Trillion seasonally-adjusted annualized rate (22% of GDP) to $35.18 Trillion. First-half total net additional borrowings were at a $2.67 Trillion annual pace, compared to the nineties yearly average of $1.28 Trillion. While second quarter borrowings were down slightly from the first quarter, they compare to total borrowings of $1.70 Trillion during 2000, $1.97 Trillion during 2001, $2.16 Trillion during 2002, and $2.64 Trillion during 2003. After beginning 1998 at 250%, Total Credit Market borrowings have increased to 302% of GDP.
Total Non-financial Credit expanded at a 7.7% annualized rate during the second quarter, down from the first quarter’s 9.1% rate. Still, one has to go all the way back to 1988 for a year of stronger non-financial Credit expansion (9.1%). And it is worth noting that non-financial growth averaged 5.4% during the last decade. The Federal Government expanded debt at a 10.7% (seasonally-adjusted) pace during the quarter, with first-half borrowings expanding at an 11.5% rate. We must go back to the deficits from the early-nineties (recession and S&L bailout) to find anything comparable. Federal debt has expanded 22% over the past 24 months to $4.27 Trillion. State & Local governments borrowed at a 7.2% rate during the first-half (4.6% during the 2nd quarter).
The Household sector expanded borrowings at a 9.5% annual rate during the quarter to $9.74 Trillion, with debt expanding at a 10.5% pace during the first-half. Total Household Borrowings are up an eye-opening 22% (matching federal debt growth) over the past 24 months. Meantime, Total Corporate borrowings expanded at a 4.4% rate during the quarter (4.6% first-half pace), with non-financial Corporate debt expanding at a 2.9% rate.
It is worth noting that Federal and Household borrowings have over the past two years increased a combined $2.50 Trillion, while non-financial Corporate debt has risen $287 billion. During the decade of the nineties, Federal and Household debt growth combined for an average annual increase of $454 billion (debt growth that took more than 5 yrs during the nineties now takes 2 yrs). There is, then, no mystery surrounding the fountainhead for robust corporate cash flows and profits. But I would warn against extrapolating the effects of historic federal and household sector debt booms too far into the future.
The Great Mortgage Finance Bubble certainly runs unabated. Total Mortgage Debt expanded by $283.4 billion during the quarter ($1.076TN seasonally-adjusted, annualized) to $9.85 Trillion. Total annual Mortgage debt growth averaged $276 billion during the nineties (what used to take a year now is done in a quarter). The first quarter’s expansion was second only to last year’s second quarter, with a growth rate of 11.8%. Total Mortgage Credit was up $1.03 Trillion over the past year (12.0%), $1.92 Trillion over two years (24%), and $4.82 Trillion over seven years (97%). Household Mortgage borrowings expanded at an 11.9% rate during the quarter to $7.57 Trillion (up 12.3% from a year ago). Home Equity borrowings (a component of Household mortgage debt) expanded by $53.6 billion, or 30% annualized, during the quarter to $766.2 billion (up 23% y-o-y). Commercial Mortgage Borrowing increased at an 11.8% rate to $1.61 Trillion. Total Mortgage Debt has inflated from 64% of GDP at the start of 1998 to 86% by the end of this year's second quarter.
The U.S. financial sector increased borrowings at a 7.9% rate during the first quarter to $11.47 Trillion. Financial sector debt has now doubled in size since the beginning of 1998. It is fascinating to follow the evolution of the financing mechanisms fueling the Credit Bubble. Years of asset inflation (securities and real estate) was fueled in large part by spectacular GSE and money market fund expansion. Yet, today, these liquidity sources have been supplanted by aggressive Bank Credit expansion (real estate and securities), ballooning foreign central bank holdings, and the mushrooming “repo” (securities financing) market. Asset inflation begets myriad institutions and individuals that aggressively seek their share of easy financial “profits.”
Commercial Bank Total Assets expanded at a 7.8% rate during the quarter to $8.2 Trillion. Bank Assets were up 8.2% from a year earlier. Bank Loans expanded at a blistering 10.9% rate during the quarter, with Loans growing at an 8.9% rate during the first-half to $4.6 Trillion. For comparison, Bank Loans expanded by 5.6% annually during 2002 and 2003. Of course, mortgage lending is leading the way. Total Bank Mortgage assets expanded at a notable 18.3% rate during the quarter to $2.44 Trillion, with mortgage loans increasing at a 16% pace during the first-half. Total Bank Credit expanded at a 10.7% rate during the first half to $6.53 Trillion, with Government Securities holdings expanding at a 21% rate to $1.25 Trillion.
Examining Bank liabilities, total deposits (checkable, savings and time) expanded at an 11.4% rate during the quarter to $4.8 Trillion. Total deposits were up 8.3% y-o-y and 17% over two years. Fed Funds & Repurchase Agreements (net) expanded at a 16% rate during the quarter to $1.01 Trillion, with two-year growth of 32%. With cheap deposit and repo finance abundant, Bank Credit Market Borrowing slowed sharply to a 4% growth rate during the quarter to $710 billion, with y-o-y gains of 11.1% (up 23.6% in 2-yrs).
There continue to be interesting developments throughout “Structured Finance.” And keep in mind that, with buoyant bank lending and deposit growth, there is today somewhat less reliance on the (non-ABS) securitization marketplace. GSE assets expanded at a 6.4% rate during the quarter to $2.83 Trillion, following two quarters of uncharacteristically slow growth (about 2%). GSE assets were up 6.9% y-o-y and were up 158% since the beginning of 1998. FHLB “Other Loans and Advances” expanded at an extraordinary 32% rate during the quarter to $558.1 billion. Issuance of GSE mortgage-backeds remained slow during the quarter (1.5%), with y-o-y growth of 7% to $3.52 Trillion. GSE MBS is, however, up 93% since the beginning of 1998.
The hot game has become “non-conforming” (higher-yielding) mortgages securitized in the ABS (asset-backed securities) marketplace. Non-GSE mortgage ABS expanded at an unprecedented seasonally-adjusted and annualized pace of $326.2 billion (more than Total Mortgage borrowings increased during any year prior to 1998). For comparison, mortgage loans comprised $80.8 billion of ABS issues during 1999, $68.7 billion during 2000, $116.8 billion during 2001, $90.1 billion during 2002, and $184.5 billion last year. In total, outstanding ABS expanded at a 12.8% rate during the quarter to $2.49 Trillion, up sharply from the first-quarter’s 3.9% growth. Total ABS was up 8.1% y-o-y and a stunning 152% since the beginning of 1998.
Other financial sector developments are worth noting. Federal Reserve assets expanded at a 10% rate during the quarter to $807.8 billion, increasing 12-month gains to 5.0%. Savings Institutions (ARM lenders) expanded assets at a 9.3% rate during the quarter to $1.55 Trillion, with assets up 11% over one year. REIT assets expanded at a 30% annualized rate during the quarter to $143 billion, with y-o-y gains of 42%. Credit Unions expanded assets at a 5.4% rate during the quarter to $643 billion (up 5.5% y-o-y). Finance Company assets declined at a 4.1% rate to $1.386 Trillion, although assets were up 11% during the past 12 months.
The disintermediation from Money Market Funds (MMF) continues. MMF assets declined at a 12% rate during the quarter to $1.912 Trillion, and were down $208.5 billion during the past year. But keep in mind that many institutions have decided to invest in money market instruments (short-term Treasuries, CP, ABS, agency debt, and “repos”) directly rather than through a fund. And while the nature of the intermediation of this Credit expansion/inflation would tend to reduce the growth rate of the monetary aggregates, it would not at all impinge marketplace liquidity.
The Broker/Dealer sector balance sheet remains quite “fluid.” After the first-quarter’s $115.8 billion surge to $1.676 Trillion (29% annualized growth), Broker/Dealer assets declined $53.3 billion during the second quarter (as interest rates spiked). This drop was almost completely explained by Treasury security sales. The Liability side saw an $87 billion reduction in Security RP (repo) to $408.3 billion, while Due to Affiliates increased by $46.1 billion (30% annualized) to $651.7 billion. Over the past year, Broker/Dealer assets have increased $163.4 billion, or 10.8%.
Funding Corp assets expanded at a 9% rate during the quarter to $1.242 Trillion, with y-o-y gains of 8.6%. Funding Corp. “Investment in Brokers and Dealers” rose $37.5 billion (38% annualized) to $428.3 billion. After two big quarters, total Federal Funds and Security Repurchase Agreements declined at an 11% rate to $1.585 Trillion. This reduced the 12-month increase to $144.3 billion, or 10.0%.
Rest of World (ROW) – the foreign sector – remains a fascinating and challenging area for analysis. Our foreign Creditors’ “Net Acquisition of Financial Assets” dipped slightly to a seasonally-adjusted annualized $956.4 billion during the quarter. Holdings have expanded at a 16% pace over the previous three quarters and were up $994.2 billion, or 12.7%, over the past year. “Official” holdings of Treasuries and Agencies expanded at a 21% rate during the quarter to $1.33 Trillion (ROW Treasury holdings increased more than Treasury issuance). “Official” holdings were up $361.6 billion, or 37%, over the past year. Holdings of “Security Repo” expanded at a 16% pace during the quarter to $552 billion, an increase of 51% from one year ago and up from $91 billion at the end of 2000. Foreign holdings of U.S. corporate debt (including ABS) expanded at a 13.7% rate during the quarter to $1.61 Trillion, with a y-o-y gain of 16%. Foreign Direct Investment increased $34.5 billion during the quarter, or 8.9% annualized, to $1.60 Trillion (up 3.3% over one year).
Confusing the issue, there were some major revisions to ROW U.S. liabilities (foreign borrowings in the U.S.). For example, last quarter’s Z.1. report had ROW Total Liabilities of $3.255 Trillion that one could net against the $8.427 Trillion of Total U.S. Financial Assets held, with net U.S. holdings of $5.17 Trillion. Yesterday’s release revised Q1 Total Liabilities a mere $905 billion higher to $4.160 Trillion. And while Foreign Assets were also revised somewhat higher, last quarter’s net foreign holdings has been revised down to $4.49 Trillion. Second quarter net foreign holdings, then, were up $658 billion, or 17%, from one year ago to $4.55 Trillion.
The Household Sector (including non-profits) remains a fruitful venue for Credit Bubble analytical insight. Household Asset holdings increased at a 6.5% rate during the quarter, while Household Liabilities expanded at a 10.8% rate. Imminent trouble? Well, it is critical to appreciate that asset values continue to inflate by nominal amounts significantly above surging liabilities – demonstrating the powerful self-reinforcing nature of Credit and asset inflations.
During the second quarter, the value of Household asset holdings increased by $900.4 billion to a record $55.97 Trillion. Meanwhile, Liabilities increased by less than one third of this amount at $263.4 billion, to end the quarter at $10.16 Trillion. Over the past year, Household assets increased $5.50 Trillion, or 10.8%, while Liabilities expanded $857 billion, or 9.3%. So despite record borrowings, Household Net Worth increased $637 billion during the quarter to a record $45.91 Trillion. Net Worth was up $4.59 Trillion over the past year, or 11.1%. Household Financial Asset holdings were up $369 billion (4.2% ann.) to $35.2 Trillion during the quarter, with 12-month gains of $3.48 Trillion (11%). Household Real Estate holdings increased by $467 billion during the quarter, or 11.2%, to $17.14 Trillion and were up $1.77 Trillion, or 11.5% over the past year. Since the beginning of 1998, Household real estate holdings have increased 76%, as inflating nominal market values more than doubled the increase in mortgage debt.
But the bottom line is that Household debt has increased more than 60% since the beginning of 1999, and this historic borrowing surge has actually accelerated of late. And while there continues to be a debate as to whether the consumer is “tapped out,” it is my view that this line of analysis misses the point. During this fateful Mortgage Finance Bubble “blow-off” period, extraordinary gains in both asset values and liquidity lend great support to consumer spending. I continue to expect consumer retrenchment to follow some type of negative financial development, rather than precipitating one.
How long with the Rest of World accumulate U.S. financial instruments at a nearly $1 Trillion annual pace? And while they are acquiring the vast majority of Treasuries issued, what types of financial and economic distortions are nurtured by artificially low yields and rampant global liquidity excesses? Does the U.S. economy’s vulnerability to inflated Household Sector New Worth become only more precarious by the year? Are market participants fooling themselves with notions that tame U.S. and global inflation lies behind the recent decline in yields? Is the Treasury market in the midst of a major “short-squeeze” and hedging/derivatives dislocation that now leaves the marketplace and the highly-leveraged U.S. financial sector acutely vulnerable to an abrupt reversal? Well, the “flow of funds” reports quite effectively illuminate the ongoing Credit inflation and financial sector leveraging that have fostered unparalleled financial fragility and specific interest-rate and currency market vulnerability. |
