For a notably volatile week, the S&P500 added 0.1% (up 5.1% y-t-d), and the Dow gained 0.3% (up 5.1%). The S&P 400 Mid-Caps gained 0.5% (up 6.8%), and the small cap Russell 2000 rose 0.4% (up 5.3%). The Banks dropped 2.4% (up 0.1%), while the Broker/Dealers fell 1.5% (up 1.6%). The Morgan Stanley Cyclicals (up 2.9%) and Transports (down 0.9%) were little changed. The Morgan Stanley Consumer index added 0.1% (down 0.4%), while the Utilities added 0.5% (up 1.1%). The Nasdaq100 gained 0.6% (up 6.4%),while the Morgan Stanley High Tech index slipped 0.3% (up 5.6%). The Semiconductors declined 0.8% (up 11.7%). The InteractiveWeek Internet index fell 0.8% (up 3.9%). The Biotechs added 1.0% (up 0.1%). With bullion up $20, the HUI gold index rallied 3.3% (unchanged).
One-month Treasury bill rates ended the week at 10 bps and three-month bills closed at 11 bps. Two-year government yields were 3 bps lower to 0.68%. Five-year T-note yields ended the week up 2 bps to 2.18%. Ten-year yields rose 8 bps to 3.49%. Long bond yields ended the week 10 bps higher to 4.60%. Benchmark Fannie MBS yields were up one basis point to 4.26%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 7 bps to 77 bps. Agency 10-yr debt spreads were little changed at 3 bps. The implied yield on December 2011 eurodollar futures slipped 2.5 bps to 0.605%. The 10-year dollar swap spread was little changed at 12 bps. The 30-year swap spread declined 1.5 bps to negative 23 bps. Corporate bond spreads were quiet. An index of investment grade bond risk was little changed at 84 bps. An index of junk bond risk was unchanged at 405 bps.
Investment grade debt issuers included State Street Bank $2.0bn, BB&T $1.0bn, Juniper Networks $1.0bn, Dominion Resources $900 million, John Deere $750 million, Cigna $600 million, Praxair $500 million, Harley-Davidson $450 million, Digital Realty Trust $400 million, Western Union $300 million and Alabama Power $250 million.
Junk bond funds saw outflows of $1.8 million (from EPFR), the first week of negative flows this year. Issuers included Valeant Pharmaceuticals $1.5bn, million, Sandridge Energy $900 million, HealthSouth $645 million, Windstream $600 million, MEMC Electronics $550 million, Level 3 $500 million, Markwest Energy $500 million, Key Energy Services $475 million, Needle Merger $450 million, Chinos $400 million, Jones Group $300 million, Isle of Capri $300 million, Comstock Resources $300 million, Consol Energy $250 million, Perry Ellis $150 million, American Renal Holdings $135 million and Credit Acceptance $100 million.
Convertible debt issuers included Old Republic International $500 million.
International dollar debt issuers included Arcelormittal $3.0bn, BBVA Bancomer $2.0bn, Bank of England $2.0bn, Cie Financement Foncier $1.5bn, Korea Development Bank $750 million, South Africa $750 million, Lithuania $750 million, Fibria Overseas $750 million, AKBank $500 million, East Lane RE $475 million, Kommunalbanken $250 million, and Capex $200 million.
U.K. 10-year gilt yields added one basis point this week to 3.63% (up 24bps y-t-d), and German bund yields jumped 12 bps to 3.27% (up 31bps). Ten-year Portuguese yields declined 4 bps to 7.38%. Spanish yields dipped one basis point to 5.37%. Irish yields gained 7 bps to 9.23%, and Greek 10-year bond yields jumped 38 bps to 12.12%. The German DAX equities index slipped 0.1% (up 3.8% y-t-d). Japanese 10-year "JGB" yields rose 6 bps to 1.30%. Japan's Nikkei gained 1.6% (up 4.5%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index jumped 1.7% (down 1.9%), while Mexico's Bolsa was little changed (down 4.3%). South Korea's Kospi index rose 2.1% (down 2.3%). India’s equities index rallied 4.1% (down 9.9%). China’s Shanghai Exchange gained 2.2% (up 4.8%). Brazil’s benchmark dollar bond yields declined 8 bps to 4.62%, while Mexico's benchmark bond yields were little changed at 4.43%.
Freddie Mac 30-year fixed mortgage rates declined 8 bps last week to 4.87% (down 10bps y-o-y). Fifteen-year fixed rates fell 7 bps to 4.15% (down 18bps y-o-y). One-year ARMs were down 17 bps to 3.23% (down 104bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates declining 4 bps to 5.42% (down 45bps y-o-y).
Federal Reserve Credit jumped $13.3bn to a record $2.519 TN (17-wk gain of $238bn). Fed Credit was up $111bn y-t-d and $256bn from a year ago, or 11.3%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/2) declined $3.6bn to $3.384 TN. "Custody holdings" were up $416bn from a year ago, or 14.0%.
M2 (narrow) "money" supply increased $10.6bn to a record $8.894 TN. Over the past year, "narrow money" grew 4.3%. For the week, Currency jumped $4.8bn. Demand and Checkable Deposits rose $22.3bn, while Savings Deposits declined $8.4bn. Small Denominated Deposits declined $2.4bn. Retail Money Funds were down $4.3bn.
Total Money Fund assets were little changed last week at $2.751 TN. Money Fund assets fell $375bn over the past year, or 12.0%.
Total Commercial Paper outstanding rose $17.4bn to $1.064 Trillion. CP is now up $95bn y-t-d, although it was down $70bn, or 6.2% from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $1.520 TN y-o-y, or 19.4%, to a record $9.341 TN.
Global Credit Market Watch:
March 4 – Bloomberg (Anne-Sylvaine Chassany): “Henry Kravis, co-founder of KKR & Co., said his firm got the cheapest financing ever to fund its $5.3 billion takeover of Del Monte Foods Co. after credit markets rebounded from the global financial crisis. ‘It’s probably the most attractive financing that we’ve ever done,’ Kravis said… ‘The financial markets rebounded much faster than the economy.’”
March 2 – Bloomberg (Jody Shenn): “Investors are pouring the most money in at least five years into publicly traded funds that buy mortgage assets, bolstering the market for the debt and reducing borrowing costs for homeowners. Annaly Capital Management… led real estate investment trusts that have raised almost $6 billion in share sales in the past three months. JPMorgan Chase & Co. estimated in a Feb. 26 report that this ‘surge’ of equity investment may fuel purchases of as much as $50 billion of additional government-backed mortgage bonds…”
March 1 – Bloomberg (Ben Martin and Bryan Keogh): “Corporate bond sales worldwide fell 28% in February, the second-biggest decline since Europe’s fiscal crisis roiled markets last May, as turmoil in North Africa and the Middle East drove away borrowers. Issuers… sold $252.7 billion of company notes last month, down from $352.5 billion in January…”
Muni Watch:
March 1 – Dow Jones (Stan Rosenberg): “U.S. state budget officials have recently become more optimistic about their revenue projections, but a new study found that they may want to re-think their views. States actually have been making serious errors in estimating their revenue in tough economic times, a development that has major implications for policy makers trying to grapple with severe budget shortfalls. That is the conclusion of a new report… by the Pew Center on the States and the Nelson A. Rockefeller Institute of Government, which said that half the states in the U.S. overestimated their revenue projections by at least 10.2% in fiscal 2009. That equated to an unexpected shortfall of almost $50 billion in personal income-tax, corporate income-tax and sales-tax revenue.”
Global Bubble Watch:
March 2 – Bloomberg (Scott Lanman): “Federal Reserve Chairman Ben S. Bernanke signaled he’s in no rush to tighten credit after the Fed finishes an expansion of record monetary stimulus, seeing little inflation risk and still-slow job growth. A surge in the prices of oil and other commodities probably won’t generate a lasting rise in inflation, Bernanke told lawmakers yesterday in semiannual testimony on monetary policy. A ‘sustained period of stronger job creation’ is needed to ensure a solid recovery, and the Fed’s benchmark rate will stay low for an ‘extended period,’ he said.”
March 1 – Bloomberg (Wes Goodman): “China, America’s largest creditor, increased its holdings of U.S. debt to a record $1.175 trillion in October… The Asian nation’s investment totaled $1.16 trillion at year-end, the Treasury Department reported… raising the figure from the previous $891.6 billion. Japan maintained its place as America’s second-largest lender, with $882.3 billion of Treasuries at year-end, compared with $883.6 billion before the revision.”
March 1 – Financial Times (James Mackintosh): “The top 10 hedge funds made $28bn for clients in the second half of last year, $2bn more than the net profits of Goldman Sachs, JPMorgan, Citigroup, Morgan Stanley, Barclays and HSBC, combined… Even the biggest of the hedge funds have only a few hundred employees, while the six banks employ 1m between them. According to the data, the top 10 funds have earned a total of $182bn for investors since they were founded, with George Soros making $35bn for clients – after all fees – since he set up his Quantum Fund in 1973.”
March 1 – Financial Times (James Mackintosh): “To the outside world, hedge funds often look much like investment banks on speed: far bigger bonuses, far bigger risks and far bigger profits. The latest figures seem to confirm that prejudice. In the second half of last year, the current top 100 funds made $70bn for their clients, and – assuming they took only the standard 20% cut – fees for themselves of about $17.5bn…”
March 1 – Bloomberg (Sapna Maheshwari): “Junk bonds are shrugging off the political turmoil in North Africa and the Middle East that drove global stocks to their worst week since November on optimism that the economy is strong enough to keep defaults contained. Returns for high-yield, high-risk bonds worldwide were little changed in the five days ended Feb. 25 as the MSCI World Index of stocks tumbled 1.56%…”
Currency Watch:
The U.S. dollar index declined 1.1% to 76.407 (down 3.3% y-t-d). On the upside for the week, the South African rand increased 2.2%, the Danish krone 1.7%, the Euro 1.7%, the Taiwanese dollar 1.3%, the Norwegian krone 1.3%, the Swedish krona 1.2%, the South Korean won 1.1%, the Mexican peso 1.0%, the British pound 0.9%, the Brazilian real 0.8%, the Singapore dollar 0.4%, the Canadian dollar 0.4% and the Swiss franc 0.4%. On the downside, the New Zealand dollar declined 1.8%, the Japanese yen 0.8%, and the Australian dollar 0.4%.
Commodities and Food Watch:
March 2 – Financial Times (Leslie Hook): “As oil prices spiral higher amid turmoil in Libya, developing countries across Asia are taking evasive action, shoring up their strategic petroleum reserves against the risk of a prolonged supply shock. Their actions could propel crude even higher. The Philippines… announced… that it would require oil companies in the country to maintain 15 days of reserves, and refineries to keep enough oil to last for 30 days. Manila’s move is the most visible sign yet of how Asian countries are seeking to improve their oil security… Analysts believe the political upheaval in the Middle East and north Africa is likely to encourage both China and India to accelerate their purchases of crude for strategic reserves… Unlike industrialised countries… China only recently began its strategic reserve programme, starting to fill reserves in 2006 and completing a 102m barrel build-out in ‘Phase One’ two years later. The second phase of the programme will build a further 168m barrels… by the beginning of next year. When China finishes filling its reserve, which it is expected to do by 2020, it will hold about 500m barrels, equal to roughly three months of imports… China’s strategic stockpiling ‘is likely to be a feature of the global oil market not only this year but this decade’, says Soozhana Choi, head of Asia commodities research at Deutsche Bank… India is some way behind China. The country is targeting a reserve of about 40m barrels, equal to little more than two weeks of imports… So far, it has only filled depots holding 9.8m barrels… ‘We are not willing to import too much at high prices. We want to buy when the price falls,’ says Wang Jun… at the Chinese government-linked think-tank CCIEE. But Mr Wang acknowledged… that China’s vulnerability to oil supply shocks was exacerbated by the lack of a complete strategic reserve: ‘Chinese dependence on imported oil for the purpose of ensuring normal economic and social functioning has become the speculation capital of international oil traders.’”
March 3 – Bloomberg (Stuart Wallace): “World steel prices rose 10% last month, according to MEPS (International) Ltd., a U.K.-based industry consultant…”
March 3 – Bloomberg (Wendy Pugh): “Cotton buyers have purchased more than 80% of the coming harvest from Australia, the fourth-largest shipper, stepping up the pace of advance sales as a shortage pushes prices to a record… The amount of so-called forward sales compared with usual levels of 50% to 60% at this time, Phill Ryan, a director of the Australian Cotton Shippers Association, said… ‘The U.S. is the biggest exporter in the world and they are sold out,’ Ryan said…”
March 4 – Bloomberg (Chris Prentice and Jae Hur): “Cotton futures surged to a record on signs that global demand from textile mills will continue to outpace supplies. Output in China, the world’s biggest consumer, fell 6.3% last year… U.S. sales surged 56% to 403,341 bales in the week ended Feb. 24 from a week earlier… Prices have more than doubled in the past year. ‘It’s a worldwide scramble,’ said John Flanagan, the president of Flanagan Trading… ‘The last holdouts realized there was no way out other than just buying, trying to find cotton to keep their mills running.’”
March 2 – Bloomberg (Debarati Roy and Isis Almeida): “A JPMorgan Chase & Co. unit took delivery of almost 1 million metric tons of raw sugar, the most for the commodity since 2009, to settle the expiring March futures contract in New York.”
March 2 – Bloomberg (Phoebe Sedgman): “Whole-milk powder prices surged to a record on sustained demand from China and concerns rising input and feed costs may curb supply, potentially boosting inflation. Powder gained 15% to $4,958 a metric ton from two weeks earlier…”
March 3 – Bloomberg (Chris Prentice): “Cocoa extended a rally to a 32-year high amid escalating violence in Ivory Coast, the world’s biggest producer. Sugar and coffee also gained in New York. Cocoa has surged more than 30% since a disputed election in late November left Ivory Coast with two rival presidents.”
The CRB index jumped 3.3% (up 9.0% y-t-d). The Goldman Sachs Commodities Index surged 4.2% (up 13.9%). Spot Gold rose 1.4% to $1,431 (up 0.7%). Silver jumped 7.3% to $35.33 (up 14%). April Crude rose $6.54 to $104.42 (up 14%). April Gasoline gained 4.7% (up 25%), while April Natural Gas dropped 4.9% (down 14%). May Copper added 0.7% (up 1%). May Wheat rallied 2.6% (up 5%), and May Corn increased 0.8% (up 16%).
China Bubble Watch:
March 4 – Bloomberg: “China’s proposed fiscal spending, including by central and local governments, may be 10 trillion yuan ($1.5 trillion) this year, according to figures given by Li Zhaoxing, spokesman for the National People’s Congress. The nation’s proposed military budget of 601.1 billion yuan is about 6 percent of national expenditure this year, Li said at a press briefing in Beijing today. That would put planned total spending at 10 trillion yuan. China last year budgeted fiscal spending for both central and local governments of 8.45 trillion yuan. Total national fiscal spending last year was 8.96 trillion yuan, the Ministry of Finance said in January.”
March 4 – Bloomberg: “As Chinese Premier Wen Jiabao this week opens the annual gathering of the National People’s Congress with a pledge to shrink China’s wealth gap, his challenge will be reflected in the makeup of the assembly itself. The richest 70 of the 2,987 members have a combined wealth of 493.1 billion yuan ($75.1bn), and include China’s richest man, Hangzhou Wahaha Group Chairman Zong Qinghou, according to the research group Hurun Report. By comparison, the wealthiest 70 people in the 535-member U.S. House and Senate, who represent a country with about 10 times China’s per-capita income, had a maximum combined wealth of $4.8 billion, data from the… Center for Responsive Politics show.”
March 1 – Bloomberg (Sophie Leung): “Hong Kong’s financial secretary caved in to protests over plans to bolster residents’ pension funds, opting to hand out cash and tax rebates that a week ago he said would stoke inflation. John Tsang said he will give HK$6,000 ($770) to permanent residents aged 18 or above, abandoning a Feb. 23 budget plan to inject the same amount into their pension fund accounts… The government also plans to give the 38% of the workforce that pays income tax a 75% rebate capped at HK$6,000.”
Japan Watch:
March 4 – Bloomberg (Yusuke Miyazawa): “Corporate bond sales in Japan are off to the best start in two years, led by Panasonic Corp.’s record offering, as companies lock in the lowest yield premiums since November 2007.”
Asia Bubble Watch:
March 3 – Bloomberg (Eunkyung Seo and William Sim): “South Korea’s industrial production grew at the fastest pace in five months as overseas demand for the country’s cars and electronics drives growth… Output increased 13.7% in January from a year earlier…”
February 28 – Bloomberg (Daniel Ten Kate and Suttinee Yuvejwattana): “Thailand’s ruling Democrat Party pledged to raise the minimum wage by 25% over two years and offer more university scholarships to improve the country’s competitiveness, spokesman Buranaj Smutharaks said.”
India Watch:
March 2 – Bloomberg (Tushar Dhara): “Indian Finance Minister Pranab Mukherjee said uncertainty in global oil prices is a ‘serious issue.’ The government needs to control spending to cut the budget deficit, Mukherjee said…”
March 3 – Bloomberg (Unni Krishnan): “India’s services industry grew in February at the fastest pace in seven months, adding to the case for the central bank to raise interest rates.”
Latin America Watch:
March 3 – Bloomberg (Matthew Bristow and Andre Soliani): “Brazil’s central bank signaled it will raise the benchmark interest rate for a third straight meeting next month, after pushing borrowing costs… to a two-year high to cool inflation. Policy makers raised the overnight rate to 11.75% from 11.25% in a unanimous vote…”
Unbalanced Global Economy Watch:
February 28 – New York Times (Jad Mouawad and Clifford Krauss): “This is no oil shock — not yet, anyway. But the events unfolding in the Arab world, the epicenter of global oil production, are a sobering reminder that trading in oil, that mother of all commodities, is at heart a political game. Not since Iraq invaded Kuwait in 1990 have the politics of crude loomed so large. Like much of the Arab world, this market seems like a pocket full of firecrackers, just waiting for a match.”
March 3 – Bloomberg (Rudy Ruitenberg): “World food prices rose to a record in February and grain costs may continue to rise in the next several months, with only rice keeping the world from a repeat of the crisis three years ago, the United Nations said…. Wheat rose as much as 58% on the Chicago Board of Trade in the past 12 months, corn gained 87% and rice added 6.5%.”
March 2 – Bloomberg (Anchalee Worrachate and Jennifer Ryan): “Euro-area inflation expectations soared to the highest level in more than two years last month as oil prices topped $100 a barrel, hampering the European Central Bank’s task as it fights the region’s sovereign-debt crisis.”
February 28 – Bloomberg (Greg Quinn): “Canada’s economy accelerated more than forecast from October to December on the biggest jump in exports since 2004 and faster consumer spending. Gross domestic product… expanded at a 3.3% annual pace in the fourth quarter following a 1.8% expansion in the previous three months…”
March 3 – Bloomberg (Johan Carlstrom and Janina Pfalzer): “Sweden’s government raised its forecast for economic growth this year after it cut taxes and as the largest Nordic economy benefits from demand for its exports. Gross domestic product will expand 4.8% this year…”
U.S. Bubble Economy Watch:
March 1 – Bloomberg (Esmé E. Deprez): “Wisconsin Governor Scott Walker proposed cutting almost 22,000 state jobs over two years and requiring workers to contribute more to their health and retirement plans to close a $3.6 billion budget deficit. The first-term Republican, whose plan to curb collective bargaining for public workers spurred protests across the U.S., would cut money for most state departments by 10% and lower public-education funds by more than $700 million.”
March 2 – Financial Times (Javier Blas and Pilita Clark): “US airlines are being forced to rethink their fuel hedging policies because of a rare divergence between the cost of jet fuel and the oil benchmark they traditionally use to insure against high energy costs. The unusual disconnect has seen a number of US airlines raise fares even though in theory they were well hedged… US airlines hedge their exposure to energy costs mostly through the popular West Texas Intermediate oil contract… While WTI prices have risen 11.6% since the beginning of the year, the cost of jet fuel in the US has risen by nearly 28% in the same period.”
March 2 – Bloomberg (Brendan A. McGrail and Matt Robinson): “Relative borrowing costs for hospitals selling municipal debt have increased by almost half in the last four months as U.S. states facing as much as $125 billion in budget deficits consider health-care spending cuts. The extra yield investors demand to hold 10-year uninsured hospital bonds instead of top-rated general obligations was 141 bps… on Feb. 25, up 46 bps since Nov. 17…”
Central Banking Watch:
February 28 – Bloomberg (Caroline Salas): “Federal Reserve Bank of New York President William Dudley said the ‘considerably brighter’ economic outlook isn’t yet reason for the central bank to withdraw its record monetary stimulus. ‘We provided additional monetary policy stimulus via the asset purchase program in order to help ensure the recovery did regain momentum,’ Dudley said… ‘A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.’”
Real Estate Watch:
February 28 – Bloomberg (Jody Shenn): “Securities backed by option adjustable-rate mortgages, the home loans that allow borrowers to decide how much they pay each month, dropped for a second week as investors speculated a rally pushed values too high. Typical prices for the senior-most option-ARM bonds fell as much as 4 cents to about 62 cents on the dollar, according to Barclays Capital…”
Favorable or Unfavorable:
I’ll apologize in advance, as this analysis would not be easy to follow even if it were written well (which it is not). I highly recommend Bill Gross’ latest, “Two-Bits, Four-Bits, Six Bits, a Dollar.” His analytical focus is directed right at key market issues: the importance of the system Credit creation baton being “handed off” from the public sector back to the private sector; market impact from the planned June termination of the Fed’s quantitative easing program; and the prospective pricing of enormous supplies of Treasury debt in a post-QE world.
I take keen interest in Mr. Gross’s thesis that “the odds of ultimate QE success seem critically dependent on several criteria:” First (1), “initial sovereign debt levels that are relatively low…” Second (2), “the ability of a country to print globally acceptable scrip – especially enhanced if that nation has the reserve currency status now ascribed to the US…” And third (3), “the willingness of creditors to believe in future real growth as a rebalancing solution to current excessive deficits and debt levels…” Mr. Gross writes that “most observers” agree with the view that the Fed’s quantitative easing plan was implemented “under the favorable conditions of (1) and (2),” while (3) is “more problematic.”
There is a tremendous amount riding on this line of analysis. And in terms of ‘ultimate success’ in the policy of aggressive public sector Credit creation and monetization, I believe that conventional thinking is missing fundamental facets of Credit and economic analysis. Without a doubt, I fear optimism surrounding the popular perception that we entered this crisis with a favorably low sovereign debt level is misplaced. Truth be told, our government debt levels were pushed artificially low by the previous historic expansion of “private” sector borrowings.
This debt backdrop has created a dynamic whereby Gross’s “(1)” appears to be a favorable policymaker asset: that the federal government sector enjoys unusual capacity to promote economic recovery through expansive borrowing and spending programs. Yet, in the end, this flexibility will afford policymakers much too long a rope – ironically amounting to a dangerous liability for the U.S. Credit system and economy, along with global stability overall. I have posited that severe structural fiscal issues from the early nineties were papered over by an unprecedented expansion of private-sector borrowings - debt that was intermediated through innovative “Wall Street finance.” It’s now payback time.
Corporate Credit expanded 9.9% in 1997, 11.7% in ’98, 10.7% in ’99, and 9.3% in 2000. During this four-year Credit boom, corporate debt surged 49% to $6.595 TN. Credit growth slowed meaningfully following the bursting of the tech/corporate debt Bubble, although policy-induced reflation ensured double-digit growth returned in 2006 (+10.5%) and 2007 (+13.1%).
Yet corporate excesses pale in comparison to the binge perpetrated by the American consumer. Household debt expanded 8.4% in ‘99, 9.1% in ‘00, 9.6% in ‘01, 10.8% in ‘02, 11.8% in ‘03, 11.0% in ‘04, 11.1% in ‘05, 10.1% in ‘06 and 6.8% in 2007. A historic Credit Bubble saw Household debt balloon 134% in nine years to $13.803 TN. This surge in finance spurred consumption and consumer-related investment, along with fostering a surge in asset prices and attendant capital gains. Tax receipts inundated government coffers from local municipalities to the halls of Congress. Politicians at all levels luxuriated in the windfall, expanding spending programs while trumpeting fiscal soundness.
The newfound – and seemingly unending - capacity to intermediate risky mortgage, household, and corporate borrowings was integral to prolonging the boom. U.S. Financial Sector debt basically expanded at double-digit annual rates from 1993 through 2007. During this period, Financial Sector Credit market borrowings jumped from $3.024 TN to $16.208 TN, or 436%. The “golden age” (1993 through 2007) of Wall Street finance saw GSE assets jump 474% to $3.174 TN; Agency MBS 251% to $4.464 TN; Asset-Backed Securities 1,080% to $4.532 TN; Broker/Dealers assets 709% to $3.092 TN; Net Repurchase Agreements 447% to $2.157 TN; and Wall Street off-balance sheet “Funding Corps” 465% to $1.849 TN.
It is today an analytical imperative to appreciate some of this Credit inflation’s key effects. Importantly, federal government receipts inflated from $1.148 TN in 1992 to $2.655 TN by 2007. A federal deficit of more than $300bn in ’92 was transformed into surpluses – and talk of paying down the entire federal debt – by the end of the nineties. More importantly, the expansion of private sector debt inflated expenditures and price levels throughout the economy and markets – spending and imports; home, stock and private business values; household incomes; corporate revenues and cash flows; and government receipts and expenditures. In the single best illustration of the scope of Bubble inflationary effects, non-financial debt growth expanded from less than $600bn annually in the mid-nineties to $2.5 TN by 2007.
The concept of “payback time” rests on the thesis that the incredible inflation of mortgage and Wall Street finance nurtured a maladjusted Bubble Economy (with myriad inflated price levels/distorted spending patterns/imbalances/Credit dependencies) that became reliant on $2.0 TN or so of annual system Credit expansion. Not only did the “private” sector boom dramatically inflate the amount of system Credit required to sustain spending, incomes and asset prices (to hold downward debt spiral dynamics at bay), it also severely impaired the creditworthiness of non-governmental debt issuers. Moreover, important facets of Wall Street risk intermediation were discredited (GSEs, CDOs, auction-rate securities, etc.). Large swaths of private sector debt have lost “moneyness” in the marketplace, and it will be quite some time (think Japan) before the moon and stars line up again for a replay of this Bubble.
As we’ve witnessed for going on three years, massive government sector borrowings now completely dominate system Credit creation (more than 100% of total non-financial Credit growth). This public sector borrowing and spending binge has indeed sustained/reflated Bubble economy price levels, although the prospect for any handoff to the private sector remains bleak. To be meaningful on a systemic basis (promoting a “handoff”), annual private sector debt growth today would have to grow from around zero to many hundreds of billions. Yet in today’s post-Bubble environment for private Credit (with household and corporate borrowers hesitant to borrow and the marketplace disinclined to finance another boom) the likelihood of a major resurgence in mortgage and corporate Credit expansion is remote.
I would argue that the government’s (Treasury and Federal Reserve) reflationary policymaking is fomenting systemic risks that actually ensure that the marketplace will lack the sufficient future appetite for private financial obligations - a prerequisite for a Credit creation “handoff.” Federal Reserve liquidity operations have been fundamental to the marketplace’s accommodation of escalating federal borrowing requirements. And each passing year of rising federal deficits ensures an even larger gulf between the total amount of system Credit creation required to sustain the boom and the limited capacity of the private-sector to begin carrying the load. Furthermore, the longer the government finance Bubble is prolonged, the greater the systemic dependency for this type of finance both from a financial and economic system perspective. Or, explained somewhat differently, the larger the government finance Bubble the smaller the potential private sector Credit impact.
Federal Reserve monetization has also exacerbated global financial system liquidity excess, as increasingly speculative global finance comes further unhinged from even a semblance of a stable “reserve” currency. Surging global food and energy prices are an increasingly conspicuous consequence of activist global policymaking, a dynamic that is no friend to U.S. household vitality or creditworthiness (or, inevitably, bond prices). And here the dimensions of the previous “private” Credit Bubble (as opposed to the seemingly favorable federal debt position) are the determining factor with respect to the scope of quantitative easing operations. Irrespective of government debt ratios, post-Bubble economic maladjustment and Credit impairment create fragilities that ensure our central bank errs on the side of ultra-low rates and aggressive monetization. I see the unfolding boom in federal finance as anything but mitigating our structural debt and economic problems.
The federal government sector did commence the post-mortgage/Wall Street finance Bubble period with manageable marketable (not including contingent liabilities) debt levels. From a Credit Bubble perspective, however, this is proving a liability. The marketplace has accommodated the greatest 3-year expansion federal debt in history, reinvigorating Bubble dynamics and re-inflating systemic fragilities. And despite Fed-induced artificially low borrowing costs, our government’s so-called "favorable" debt ratio has deteriorated rapidly.
The government sector is now well on its way toward impairing its creditworthiness. And while diminished, the dollar’s status as reserve currency (“ability of a country to print globally acceptable scrip”) has been instrumental in the ability of global central bankers to “recycle” the unending surfeit of dollar balances right back into our securities markets. In this respect, I would argue another “asset” is proving a quite unfavorable Bubble-fomenting “liability.” These days, our government finance Bubble has counterparts all around the world, in an environment of Monetary Disorder and increasingly unwieldy global finance.
In the final analysis, when it comes to gauging the probability of “ultimate success,” I fear that our policymakers have pilfered our nation’s assets for the perpetuation of problematic – and in the end unsustainable - Bubble dynamics.
