CREDIT BUBBLE BULLETIN
Off the scales
Commentary and weekly watch by Doug Noland
Bloomberg's Mark Pittman and Bob Ivrya reported last Tuesday: " ... the US government has pledged more than US$11.6 trillion on behalf of American taxpayers over the past 19 months, according to data compiled by Bloomberg. Changes from the previous table, published February 9, include a $787 billion economic stimulus package. The Federal Reserve has new lending commitments totaling $1.8 trillion. It expanded the Term Asset-Backed Lending Facility, or TALF, by $800 billion to $1 trillion and announced a $1 trillion Public-Private Investment Fund to buy troubled assets from banks. The US Treasury also added $200 billion to its support commitment for Fannie Mae and Freddie Mac ... "
The administration's new budget projects an astounding $1.75 trillion fiscal 2009 federal deficit - or about 12% of GDP. Federal outlays are expected to surge 32% this year to $3.94 trillion. In nominal terms, the deficit is set to quadruple the previous all-time record. In percentage terms one has to return back to the war economy of the 1940s to find anything comparable.
On Thursday, Fannie Mae reported a fourth-quarter loss of $25.2 billion, bringing the company's second-half 2008 shortfall to more than $50 billion. Non-performing assets surged a stunning 87% during the quarter to $119.2 billion, a three-fold increase in just 12 months. Having more than depleted its razor-thin capital base, Fannie requested $15.2 billion of additional Treasury support (from the $200 billion promised).
The Federal Deposit Insurance Corporation (FDIC) announced on February 26 a $26.2 billion fourth-quarter 2008 loss for the banking system. The Office of Thrift Supervision reported that the country's savings & loans lost $3.0 billion during the final quarter of the year, increasing 2008 losses to a record $13.4 billion. General Motors announced a $9.6 billion fourth-quarter loss, increasing its annual loss to a staggering $30.9 billion. Analysts are expecting even greater losses to be reported at AIG and Citigroup.
The dimensions of the reported deficits and losses are not easily digested; the scope of the present systemic problems are not so easily comprehended. I'll push ahead with efforts to use the credit bubble framework as an analytical tool for making some sense of the historic nature of the unfolding bust.
Let's try to place the various huge and increasingly numbing deficit/loss numbers (attendant with this bust) into coherent context. For such an endeavor it is imperative first to examine the preceding boom. This week, in particular, seems an appropriate time to summarize, in credit terms, the incredible dimensions of the fateful inflationary bubble.
From the Federal Reserve's "flow of funds" report, we can see that total system credit (non-financial and financial) ended 1995 at $18.475 trillion. By the end of 2007, this number had inflated to $49.882 trillion, for growth of 170% in only 12 years. During this period, household debt swelled 184% to $8.959 trillion; non-farm corporate debt 130% to $3.832 trillion; and state and local government borrowings 109% to $2.192 trillion. Federal debt expanded "only" 41% to $5.122 trillion. Rest-of-world holdings of US assets inflated 365% to $16.048 trillion. While significantly trailing credit growth, gross domestic product nonetheless bulged 87% during this period.
Over the past decade, the "optimists" often cited the federal government's positive fiscal position as evidence of the health of the overall economy and soundness of our prosperity. It should be clear these days that the protracted boom's massive inflation of private-sector credit had grossly inflated government receipts (among other things). Indeed, over the 12-year period federal receipts inflated 88% (to $2.651 trillion) and state and local receipts increased 92% (to $1.903 billion). This crucial facet of the inflationary boom spurred federal and state and local spending growth of 80% and 93%, respectively.
State and local governments will now attempt to maintain these inflated levels of expenditures, while the federal government will move aggressively to grossly inflate already inflated spending. The budget now calls for federal expenditures this year to approach $4.0 trillion. This compares with spending of about $1.6 trillion back in 1995. The federal deficit is projected to expand by a combined $3.0 trillion during fiscal years '09 and '10. This would amount to a 60% increase in federal debt in only two years.
Today's unparalleled expansion of federal debt and obligations is being dressed up as textbook "Keynesian". It's rather obvious that we are in dire need of some new books, curricula and economic doctrines. But from a political perspective, the title is appropriate enough. From an analytical framework perspective such policymaking is more accurately labeled "inflationism" - a desperate attempt to prop inflated asset prices, incomes, business revenues, government receipts, and economic "output". There have been many comparable sordid episodes throughout history, and I am not aware of any positive outcomes.
The administration's budget earmarks an additional $750 billion as a contingency for added financial sector bailouts. Fed data nicely illuminate the dimensions of the financial sector's problem. Between 1996 and 2007, total mortgage debt expanded 220% to $10.061 trillion. Total GSE agency securities (debt and MBS) tripled to $7.397 trillion. The ABS market inflated 580% to $4.50 trillion. Over this 12-year period, bank assets swelled 150% to $11.194 trillion. Securities broker/dealer assets ballooned 440% to $3.10 trillion.
In 12 years, total financial sector borrowings expanded 300% to $16.90 trillion - in the process creating a credit and liquidity junky out of US asset markets and the real economy. Today, the deeply impaired financial sector is incapable of assuaging the system's bloated credit needs.
For perspective, a little compare and contrast is in order. Total mortgage debt increased $188 billion in 1995, compared with $1.437 trillion growth in 2005, $1.410 trillion in 2006, and $1.098 trillion in 2007. Agency MBS increased $98 billion in 1995, compared to $609 billion growth last year. The ABS market grew $127 billion in 1995, in contrast to the $725 billion growth in 2005 and 2006's $808 billion. Bank credit expanded $273 billion in 1995, compared to 2007's $788 billion and 2008's $1.294 trillion. Broker/dealer assets expanded $113 billion in 1995, against 2007's fateful $615 billion growth.
This unprecedented credit explosion inflated asset prices as well as incomes. Between 1996 and 2007, national incomes inflated 90% to $12.271 trillion. Compensation of employees surged 86% to $7.812 trillion. Bubble impacts were even more dramatic with respect to the household (including non-profits) balance sheet. In 12 short years, household sector asset holdings inflated $43.685 trillion, or 133%, to $76.549 trillion. Despite household liabilities surging 185% to $14.379 trillion, household net worth (assets minus liabilities) inflated $34.360 trillion, or 124%, to $62.170 trillion.
Importantly, this massive inflation of perceived financial wealth over years glossly distorted the quantity and pattern of spending throughout the real economy.
This historic credit-induced inflation of household incomes and net worth was at the core of deep structural maladjustment to the US "bubble" economy. The implosion of "Wall Street finance" (in particular the collapse of broker/dealer financing, private-label MBS and other ABS, and various methods of leveraging mortgage, corporate and other securities) marked the demise of various bubbles, including ones in private-sector debt securities, residential and commercial real estate, equities, and household net worth more generally.
In the final analysis, the bust has left multi-trillion dollar holes in various sector balance sheets. Moreover, patterns of spending throughout the economy have been forever altered. Year-after-year of reckless lending has quickly come home to roost in a big way.
Our federal government has commenced the process of attempting to fill holes through the massive inflation of government credit and obligations (by the trillions). Depending on the reader's perspective, I risk appearing either the master of the obvious or a rabid sensationalist. Yet the stakes associated with the current course of fiscal and monetary policy are absolutely momentous. And I am compelled to write that "if you're not confused you don't understand the nature of the problem".
What are the ramifications and consequences associated with US deficits approaching 12% of GDP? Over the short and intermediate terms? Will unprecedented fiscal and monetary measures stem financial sector implosion? Will Washington's efforts work to bolster a faltering bubble economy, or will they instead only tend to delay unavoidable structural adjustment? Will the Treasury market continue to so easily accommodate reflationary efforts? How long will the dollar remain relatively stable in the face of massive growth in US non-productive credit? Will multi-trillions of government debt and obligation expansion help to resuscitate private-sector credit creation - or will it instead simply destroy the creditworthiness of the entire economy?
Not uncharacteristically, I pose more questions than I have answers. But I do fear that we now face trillion-dollar deficits as far as the eye can see. I don't expect "Keynesian" policies to have much success in reinvigorating busted asset markets. I'll be surprised if private-sector credit creation bounces back any time soon. I fear policymaking will do more harm than good when it comes to needed economic restructuring.
And my worst fears of policymaking (fiscal and monetary, Democrat and Republican, national and local) bankrupting the country are being anything but allayed. Similar to my belief that mortgage credit growth should have been limited to, say, no more than 4% or 5% annually during the boom, there is today a very serious need to incorporate some reasonable limits on the expansion of federal debt and obligations.