Always consider hidden risks
In US Debt We Trust - The Transfer from Private to Public Debt
( From Economics Help, FSA , Financial Sense )
Total US debt – Public + Private
Recently, there has been much focus on US public sector debt – the total amount the government borrows. These graphs show the combined debt levels of both the public and private sector. Private sector debt is split up into households, non-financial companies and financial corporations. Observe the huge shift from the private debt to public debt since 2008.( See graph below )
In the run up to the 2007 financial crash, we have a rise in total debt levels. – especially amongst households, and financial. Note debt to GDP continues to rise in 2008/09 – because GDP fell sharply in these years.
From 2009, we see a fall in debt levels in the private sector (non-financial corporations, financial firms and households all see lower debt to GDP). This is what you would expect in the aftermath of credit crisis, housing slump and recession – firms and households seek to improve their balance sheets – pay down debt, increase saving, reduce investment and reduce consumer spending.
From 2008 to 2012, US government debt increases from below 60% to 90% of GDP. But, placed in this context of falling debt levels in other areas of the economy, it sheds a different light.
Undoubtedly, the rise in US government debt helped to offset the fall in private sector spending and investment. If the government, had attempted to reduce the budget at a quicker rate or if they had attempted to maintain government debt at some pre-determined level, the US wouldn’t be seeing the economic recovery it is seeing.
A very crude and simplified explanation of Keynesian economics is that falling private sector spending should be offset by rising government spending – even if the government has to borrow from the private sector.
The fact that the private sector is wanting to pay down debt and increase savings, means that there is higher demand for government bonds, and this is why bond yields have fallen during this period of rising government debt.
Of the deleveraging challenge we now face, as a result of our past failure to control adequately either private debt or public debt creation, is so severe that it is likely to require a response which combines all of the possible mechanisms – debt servicing, debt write-down, and forms of controlled debt monetisation.
And a look at the big picture ( See graph below )
There are not less US debt : Its only a transfer from the Private Sector to the Public Sector
The entire notion of deleveraging is maybe a mirage... For Now...
“U.S. debt has shrunk to a six-year low relative to the size of the economy as homeowners ( Q2 2012 ), cities and companies cut borrowing, undermining rating companies’ downgrading of the nation’s credit rating. Total indebtedness including that of federal and state governments and consumers has fallen to 3.29 times gross domestic product, the least since 2006, from a peak of 3.59 four years ago…
Private-sector borrowing is down by $4 trillion to $40.2 trillion. Reduced borrowing means there is less competition for the U.S. Treasury Department as it sells debt to fund spending programs to help the nation recover from the worst financial crisis since the Great Depression. Credit-rating firms are discounting the improvement even as debt, equity and currency markets suggest the U.S. is more creditworthy than before Standard & Poor’s stripped the nation of its AAA grade in 2011.
Total system Credit Market Debt Outstanding ended Q2 2012 at a record $55.031 TN. As a percentage of GDP, this was 352.6%, down from 371.6% at the end of 2008. I’ll attempt to explain why this actually does not reflect system debt deleveraging.
Total system-wide Credit Market Debt combines Total Non-Financial Market Debt along with Financial Sector Credit Market Debt (FSCMD). Total Non-Financial Market Debt ended Q2 at a record $38.924 TN - and 249% of GDP. This compares to Q4 2008 total Non-Financial debt of $34.479 TN - and 240% of GDP. The post-2008 decline in total debt and the improvement in the ratio of total debt/GDP are predominantly explained by the contraction in Financial Sector Credit Market borrowings. Total FSCMD peaked at $17.123 TN during Q4 2008, or 119% of GDP. Total FSCMD ended Q2 2012 at $13.838 TN, down $3.285 TN to 89% of GDP. There are crucial Credit Dynamics at work here worth exploring.
Financial Sector Credit Market Debt ended year 2000 at $8.168 TN. GSE issues (agency debt and MBS) and Asset-Backed Securities (ABS) ended 2000 at $4.320 TN and $1.504 TN, respectively. The market debt of Depository Institutions, Finance Companies and REITs combined for $1.506 TN, while Brokers & Dealers, Holding Companies, and Wall Street Funding Corps ended at a combined $831bn.
Let’s fast-forward to December 31, 2008, after mortgage Credit had more than doubled. FSCMD ended the year at $17.123 TN, up 110% in eight years of historic “Wall Street Alchemy.” The process of transforming increasingly risky debt into beloved instruments (specially-made for leveraged speculation) saw GSE debt/MBS jump 89% to $8.142 TN. ABS, largely “private-label” Wall Street mortgage-backed securities, ballooned 174% to $4.123 TN. Depository Institutions, Finance Companies and REITs saw their combined Market Debt increase 70% to $2.227 TN. Meanwhile, at the heart of the “alchemy,” Brokers & Dealers, Holding Companies, and Wall Street Funding Corps combined for Market Debt of $2.204 TN, an increase of 165% in eight years.
Now, let’s update the data for the post-Mortgage Finance Bubble backdrop. As noted above, Total FSCMD ended Q2 2012 at $13.838 TN, a decline of $3.285 TN since the conclusion of 2008. GSE debt/MBS declined $626bn, or 8%, to $7.517 TN, a rather modest contraction considering their dismal financial circumstances. Notably, ABS dropped $2.267 TN, or 55%, to $1.856 TN.
The three Trillion-plus contraction in FSCMD did reduce Total System Market Debt – in the process seemingly improving debt-to-GDP ratios. It is not, however, indicative of true system deleveraging and surely doesn’t reflect an improvement in our nation’s overall Credit standing. Far from it. From a Macro Credit Analysis perspective, the decline in FSCMD is instead reflective of fundamental changes in both the type of debt now fueling the boom and the corresponding nature of system risk intermediation.
First of all, mortgage debt is about to wrap up its fourth straight year of post-Bubble contraction. Problem loan charge-offs have played a significant role, as have individuals using lower debt service costs (and near-zero returns on savings!) to speed the repayment of outstanding mortgages. And, importantly, the decline in home values and the steep drop in transaction volumes have reduced demand for new mortgage debt – hence the need to intermediate mortgage Credit. That said, the biggest factor behind the drop in FSCMD has been the activist Federal Reserve.
The Fed’s balance sheet is separate from the Financial Sector. Federal Reserve Assets ended 2007 at $951bn. Fed holdings ended Q2 2012 at $2.882 TN, up $1.931 TN, or 203%, in 18 quarters. The Fed essentially transferred $2 TN of Financial Sector liabilities to a secure new home on its balance sheet. Some may refer to this as “deleveraging,” but I won’t.
Importantly, the Fed’s moves to collapse interest rates and monetize debt (in conjunction with mortgage assistance programs) incited a major wave of mortgage refinancing. And through the refi process, large quantities of private-label mortgages (previously included in FSCMD as ABS) were essentially transformed into sparkling new GSE-backed mortgage securities – and many then conveniently found their way onto the Federal Reserve’s rapidly inflating balance sheet. This provided critical liquidity that allowed highly-leveraged Wall Street proprietary trading desks, hedge funds and banks to de-risk/de-leverage. This bailout accommodated deleveraging for the financial speculators, yet for the real economy the boom in Non-Financial debt ran unabated.
As noted above, Total Non-Financial Market debt ended this year’s second quarter at $38.924 TN and 249% of GDP – both all-time records. Garnering all the focus from the deleveraging crowd, Total Household Debt has indeed declined since 2008 – having dropped $787bn, or 5.8%, to $12.896 TN. At the same time, Federal debt has increased $4.689 TN to $11.050 TN. Non-Financial Corporate debt increased $434bn since ’08 to end Q2 2012 at a record $11.990 TN. State & Local debt has expanded $101bn since ’08, ending Q2 at about $3.0 TN. The data is the data - and Deleveraging is a Myth.
A 100% increase in Federal debt and 200% growth in the Federal Reserve’s balance sheet are surely not indicative of system de-leveraging. Such extraordinary Credit developments do, however, have profound effects throughout the markets and real economy. The ongoing Credit expansion has inflated incomes, spending, corporate earnings and securities prices, in the process sustaining for now the U.S. economy’s Bubble structure. And I would argue strongly that the data support the thesis that our system remains dominated by Bubble Dynamics.
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