It was an erratic and disappointing end to an erratic and quite difficult week. For example, today the AMEX Securities Broker/Dealer index surged more than 6%, with Charles Schwab, TD Waterhouse, E-Trade, Knight/Trimark, Siebert Financial, National Discount Brokers, Morgan Stanley Dean Witter and Goldman Sachs all gaining more than 10%. Individual stocks and sectors continue to make wild and unpredictable moves in what is an acutely volatile and disjointed marketplace. This week the S&P Bank index jumped 19%, with the entire gain coming on Wednesday and Thursday. For the week, the Dow and Morgan Stanley Cyclical index jumped 7%, the S&P500 5%, Utilities 6% and the Morgan Stanley Consumer index 11%. The Bloomberg Wall Street index surged 12%. And despite the strong gains over the past two sessions, some air did begin to come out of the most speculative sectors this week. The semiconductors and NASDAQ Telecommunications indices dropped 6%, reducing year-to-date gains to 78% and 14%. The NASDAQ100 and The Street.com Internet index declined 3%, while the Morgan Stanley High Tech index was unchanged. The small cap Russell 2000 dropped almost 5%, reducing its 2000 gain to 14%. This extreme volatility and the fact that derivatives have come to play such a key role in the stock market should certainly not be seen as indicative of a healthy marketplace.
Despite surging stock prices, there was little in the way of relief for key areas of the credit market. As unusually strong demand stoked prices for Treasuries, long-bond yields dropped almost 18 basis points this week to 6%. The key 10-year Treasury yield also declined 18 basis points to 6.19%. In such an unsettled environment, not surprisingly, mortgage-backed securities continue to under perform. This week the spread between the current coupon Fannie Mae 30-year security and the 10-year Treasury widened 8 basis points to 170. This spread was 124 on January 26th. The spread on the 10-year US dollar swap, a key hedging instrument, widened 4 basis points this week to 109, although it did narrow from the record 115 where it traded intra-day Wednesday. Spreads also increased this week in the corporate sector, in what we see as important evidence of a broadening of the stress that has been to this point, largely confined to mortgages and the swaps market. There was also talk this week of spreads widening in some Asian and emerging market debt instruments.
We see that broad money supply expanded by $45 billion last week; the largest weekly gain so far this year. Are we seeing the financial sector once again moving to create its own liquidity in response to heightened systemic stress – working to create additional money and credit? And, was this renewed explosion of money creation additional fuel for the option expiration week meltup in the stock market? It is impossible to know, but there is absolutely no doubt that the US financial sector continues to work aggressively to perpetuate history’s greatest credit bubble. Looking at the latest data, bank credit has expanded by $204 billion during the past four months, a 13% annualized rate. Ninety-six billion of this new credit was directed to the property markets, as real estate lending expanded at a rate of 20% during this period. Commercial and industrial loans have increased $36 billion, an 11% rate, and consumer loans have grown $28 billion, an 18% rate. Elsewhere, the margin debt numbers are absolutely frightening. During the four months November through February, margin debt ballooned to $265 billion, an increase of $83 billion, for an annualized growth rate of 136%. For comparison, total margin debt began 1997 at $99 billion.
The fourth quarter Federal Reserve Z1 report is out, and it certainly confirms that 1999 was an historic year in credit creation, making it back-too-back years of egregious and absolutely reckless debt growth. Actually, the numbers are simply astonishing and should be viewed in the context of the parabolic nature of credit growth that impairs the soundness of a financial system during the late stage of a boom. For the year, household mortgage debt expanded at a rate of 10.4%, corporate debt at 11.7%, and the domestic financial sector expanded debt at a rate of 17%. The financial sector added $1.09 trillion of additional debt, its second straight year of growth surpassing $1 trillion. Alarmingly, financial sector debt now totals $7.6 trillion, having increased 40% during the past two years and 78% since 1995. For 1999, there was approximately $5 of additional debt for each $1 of additional GDP growth.
During 1999, total non-financial debt increased a record $1.1 trillion, an increase of about 10% above 1998’s credit growth. For comparison, last year’s non-financial debt growth was 43% greater than 1997’s increase of $776 billion. Total mortgage debt increased $601 billion in 1999, 20% greater than mortgage debt growth in 1998 and almost double that of 1997. Commercial mortgage debt increased $122 billion during 1999, this compares to $97 billion in 1998, $51 billion in 1997 and $28 billion in 1996. Corporate debt growth was a record $444 billion, compared to $406 billion in 1998, $286 billion in 1997 and $155 billion in 1996. The GSEs were hard at work again in 1999, issuing a net $592 billion in new agency securities. This compares to agency issuance of $473 billion in 1998, $213 billion in 1997 and $230 billion in 1996. Adding to their already enormous holdings of financial assets, the highly leveraged government-sponsored enterprises acquired $316 billion of assets during 1999. This surpassed even 1998’s historic expansion. For comparison, the GSEs acquired $111 billion of assets in 1997.
There was a staggering $25.6 trillion of credit market debt outstanding at the end of 1999, having increased $2.25 trillion during the year. Total outstanding credit market debt increased $2.1 trillion during 1998 and about $1.4 trillion for both 1996 and 1997. Interestingly, 1994 was the first year that credit market debt growth surpassed $1 trillion; now our system easily creates twice this amount of additional marketable debt securities and no one raises an eyebrow. Importantly, much of this additional debt growth is being purchased by leveraged institutions. As mentioned earlier, the financial sector has accumulated $7.6 trillion of credit market debt. Of this, $713 billion has been borrowed by the commercial banks, savings institutions and credit unions, $654 billion by finance companies, $1.6 trillion by government-sponsored enterprises, $2.3 trillion by federally regulated mortgage pools, $1.6 trillion by asset-backed securities issuers, $511 billion by funding corporations and $213 billion by “other”. Note what a small percentage of credit market debt growth is coming from the banking system.
Thus far, we have placed considerable focus on money in this forum, as it is our contention that our monetary system has spun out of control and is being poisoned by unsound practices. Money excess, however, is but one critical aspect of this massive credit bubble. In fact, excesses in money creation are easily matched by excesses throughout the entire credit creation process. In both cases, Wall Street is the leading instigator.
During the fourth quarter, the financial sector took on an additional $264 billion in borrowings. Of this, commercial banks borrowed $16 billion, savings institutions and credit unions $4 billion, finance companies $22 billion, and REITs and mortgage companies $6 billion. Insurance companies actually paid back about $1 billion of borrowings during the fourth quarter, and the Brokers and Dealers paid down $9 billion. The big borrowers were the government-sponsored enterprises at $92 billion, the federally regulated mortgage pools at $94 billion, the asset-backed securities issuers at $29 billion, and the funding corporations at $63 billion. Clearly, the additional leverage created by the GSEs, mortgage pools, asset-backed security issuers and funding corporations are at the core of the US credit bubble.
In the past, we have witnessed several episodes where heightened systemic stress was the catalyst for periods of extreme money and credit growth. Certainly, the Mexican bailout in 1995, the Asian crisis in the fall of 1997, the Russian/LTCM collapse in the second-half of 1998, and the gold dislocation and Y2K fears of last autumn, are good examples. In each instance, the financial sector moved aggressively to increase leverage and generate the money and credit growth necessary to perpetuate the US credit bubble. We have little doubt that the financial sector will continue to work feverishly to keep the game going. Certainly, there is much at stake.
It is our view, however, that the environment today is much less conducive to perpetuating the bubble than it has been in the past. Currently, dangerous distortions and imbalances in both the financial system and economy are significantly worsened by additional money and credit excess. First, the increasingly maligned US economy is desperately overheated, with inflationary pressures greater today than they have been in many years. The stock market is absolutely dysfunctional and an obvious speculative bubble, fostering a breakdown in the effective allocation of capital. There are also massive trade deficits destined to only grow more extreme as imports are left to satisfy the credit-induced excessive demand. We see this week that February imports into the Port of Los Angeles were 25% above last year’s level.
Clearly, the last thing the economy needs right now is for the over-zealous US financial sector to take on additional leverage and create more liquidity for the household and corporate sectors. The risk is simply too great to allow only more extreme leverage to develop within the acutely vulnerable financial sector. Instead, the goal should be a slower and more balanced economy, not the perpetuation of the bubble. As such, the Fed needs higher market interest rates and lower stock prices to temper dangerously overheated demand. However, financial markets are not cooperating, with Treasury yields sinking and stock prices surging. Sure, this is playing into the hands of the stock operators. But it should now be apparent to the Fed and anyone paying attention, that this has become a very dangerous game – one not easy to control. Clearly, the Fed has its work cut out as it attempts to let air out of this momentous bubble slowly.
