Debt, Wealth & Keynesianism

Fun with data - Quarter 4 Flow of Funds Report -


As far back as this report goes, private sector credit outstanding has been growing. Clearly, nothing can grow forever.

Quarter 4 of 2008 has shown quite a different picture. Consumer credit as a whole has contracted, a first time occurrence as far as this report shows in this 31 year history. The corporate sector has still managed to increase their debt outstanding, albeit at a slower pace, but corporate debt default rates are at record levels right now. Foreign credit has been contracting even more severely, but as a whole foreign credit is much smaller in scale. The government and their keynesian clown economists have blown their credit growth sky high in attempts to revitalize the economy.

It's important to put this in relative terms, please review the following:


Significant credit was created via our government and financial institutions in 2008. Nowadays, there's hardly a distinction since large parts of these government borrowings immediately flowed into the accounts of financial institutions to "spur lending". Of course we all know the money is just being used to cover losses and maintain solvency ratios. Technically insolvent and failed banks are transformed into zombie banks as a result. What is especially striking about financial institutions raising more debt is that as more and more of their assets need to be written down, they are then required to raise more capital as a result of adding to their liabilities. It's a never ending cycle until the LIABILITIES are addressed, namely long and short term debt.

There is more to this story on the consumer side:


The change in wealth in 2008 has been enormous, especially in Q4. For the entire year household net worth declined by $11.2 trillion! In all of 2008 the federal government increased its debt outstanding by $1.24 trillion. This does not include Federal Reserve programs.

Where am I going with this?

Consumers are paying down or defaulting on their debt and at the same time losing enormous amounts of wealth (in many cases their jobs too). The government is borrowing more in an attempt to keep financial institutions solvent so they can lend more to consumers and businesses. What consumer or business is going to borrow in this environment? Essentially this is just a transfer of wealth from the taxpayers to financial institutions and is incredibly ineffective, immoral, unconstitutional and socialist.

The Promise of 2009

With all of the talk of green shoots most analysts sure are ignoring reality. In my opinion the credit contraction that really just began in the 4th quarter of 2008 will spread in 2009. Let's refer back to my previous post Turning Points:

Stress-Tested Banks May Struggle As Bad Assets Triple:

The tests on the 19 largest banks are likely to focus in part on loan quality as a measure of health. The lenders, which may need to raise $1 trillion in capital to cushion losses according to an April 23 KBW Inc. report, may have a hard time persuading investors to give them cash.
...
New York-based JPMorgan’s nonperforming assets grew 185 percent in the past year to $14.7 billion, or 0.7 percent of the firm’s total. Bank of America Corp., based in Charlotte, North Carolina, said bad assets increased 229 percent to $25.7 billion. Problem assets at New York-based Citigroup Inc. rose 128 percent to $27.4 billion, and San Francisco-based Wells Fargo & Co.’s jumped 180 percent to $12.6 billion.

Junk Bond Defaults To Reach Record By March, S&P Says:

Junk-rated companies have about $177.5 billion of debt maturing in 2009 and $179 billion coming due in 2010, including bonds and bank loans, S&P said. So-called junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

Sixty-one companies have defaulted this year as of April 17, three times as many as during the same period a year ago, and affecting $200 billion of debt, S&P said.

The record rate of defaults for high-yield, high-risk, or speculative-grade bonds is 12.5 percent in June 1991, S&P said.

IMF Puts Global Bank Losses From Financial Crisis At $4.1 Trillion:

the I.M.F. estimated that banks and other financial institutions faced aggregate losses of $4.05 trillion in the value of their holdings as a result of the crisis.

Fannie & Freddie Delinquencies Soar (and they are going to get much worse)

All loans 60+ days delinquent increased from 834,831 as of November 30 to 1,229,051 as of January 31, representing an increase of 47 percent over the period. However, prime loans 60+ days delinquent increased by 69.6 percent while nonprime loans increased by 23 percent.

Fed's Losses Dominated By Commercial Real Estate:

The Fed wrote down the value of former Bear Stearns commercial-mortgage holdings by 28 percent to $5.6 billion and residential loans by 38 percent to $937 million as of Dec. 31, the central bank said today. Properties in California and Florida accounted for 45 percent of outstanding principal of the residential mortgages.

Reality is grim indeed. Coming soon are increasing mortgage defaults, commercial real estate loan defaults, credit card loan defaults, corporate debt defaults and not even mentioned here are public pension fiascos soon on their way. Yeah, but aren't the banks profitable now? Please see Bank Profits Are Accounting Shenanigans to see why recent bank profits are misleading.

Can We Count On The Consumer To Borrow Again?



Real unemployment is at 15.6% and rising. Anyone looking for green shoots is simply out of their mind?

What About The Fed?

The Fed, just as the federal government is aiming its arrows in the direction of financial institutions. However, with the consumer in retrench, this will not create inflation since on net, consumer borrowing is contracting and unemployment rising. Again, this is a transfer of wealth from taxpayers to financial institutions.

The Fed is limited in its power. It has already grown its balance sheet to nearly $2 trillion, but just look at these ratios. Credit outstanding is simply many times the current size of the Fed's balance sheet. (note: the above monetary base is in billions of dollars). As a result, their "printing" has been limited in its effectiveness. Why? Because of the simple fact that the Fed is filling holes on the asset side of the balance sheet while encouraging the liability side of financial institutions balance sheets to rise. The path is circular and the only way to stop it is for all parties to grow up and start restructuring. What is not shown here is the even more extraordinary level of derivatives and securitizations outstanding, dwarfing every other $ measure seen here.

Finally, two important points to consider. First, the velocity of money is in free fall:


The likelihood of inflation in the face of velocity cliff diving is low. Indeed deflation is the more likely result. The Fed can make money available to financial institutions, but they are simply going to hoard it for future losses and the pool of qualified borrowers has shrank considerably.

Next, where is most of this federal borrowing and Federal Reserve alphabet soup lending going?


Financial institutions are hoarding the money, that's where all of this money has gone.

In summary, demand for money is extremely high right now; we know this because velocity has fallen sharply and net consumer lending is contracting, personal savings are increasing and all of the Keynesian and monetarist clowns are ignoring what is right in front of their face. Imbalances have existed for far far too long and this is the inevitable consequence. The solution cannot be more of the same imbalances.

The future will be determined partly by social mood and political will in addition to the simple balance sheet debt problems outlined above. Slowly, the public is growing outraged over the course our politicians are taking. Therefore, social mood which governs the level of optimism and pessimism of consumers is more negative. With negative social mood I would say it's safe to assume that a great lending and investment boom is far far away. Political will can play a role, but at great risks. There is the risk that Bernanke will devise a scheme in which the "printing" he is doing will in fact reach more than a bank's excess reserves where it will is only be allocated to future losses. I don't know what that scheme looks like but I know the result...inflation or hyperinflation (currency collapse). The future is undecided, but until the evidence changes my vote is still on the side of deflation and that vortex is still ongoing.

The 2009 Q1 Flow of Funds report is due in June; we'll see if my predictions are in fact correct.