Relevant and even prescient commentary on news, politics and the economy.

The Scariest Graphic I Made All Week, or, Still More on Excess Reserves and "Money"

One of the nice things about the Kauffman Foundation’s Blogger Conference is the time to let the mind wander and look at data after having your brain scoured.

One of the worst things is realizing too late that you’ve got a Really Ugly Graphic, and most of the people who could help with it are gone.

Four hours ago at dinner, I was sitting between Brad DeLong and Tim Duy (who pointed out some good contemporary performers of Real Country Music), but I didn’t have this graphic with me. Now Tim is on a plane and Brad is teaching students, and my best option is to ask the AB commentariat if the following graphic scares them as much as it does me.

Even given my hobby-horse attitude toward Excess Reserve (i.e., the Sheer Unmitigated Contempt with which I treat the idea that reserves in general—let alone Excess Reserves—should “earn” interest), the dropping-off-a-cliff impression (and the overall downward trend, even keeping in mind that we do not Seasonally Adjust Excess Reserves, and therefore Seasonal Effects are clear) almost seems to explain why the 32nd month of the “recovery” feels as if it’s just possibly starting something.

To be fair—and a hearty “thank you” to Jeff Miller of A Dash of Insight for reminding me that most people believe the Fed concentrates on M2, not M1—the broader index shows an upward trend (again, discounting the recent decline as a Seasonal Effect):

Otoh, an overall ca. 5% increase in “Net M2,” as it were, over a year in which the dollar has increasingly appeared to be the only reasonable “Safe Haven” doesn’t seem all that large either.

I’ve yet to play with the data beyond this, so I leave it to the AB comentariat:

  1. Do you believe there is something here?
  2. If so, any guesses what it is? Or anything you want to know about it?
  3. If not, what else should we be looking at where Excess Reserves may/should/will (depending upon your degree of certainty) affect the value of the data and/or Real Economic Growth?

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Sources and Uses: Kash Delivers

Two posts on European Banks and their view of what constitutes a “Safe Harbor.”

His conclusion isn’t just The Pull Quote of the Year, it’s the Pull Quote That Explains the Year:

Putting it all together yields a compelling story: European banks are shifting their cash assets out of European banks and putting much of them into US banks. (An interesting question is what European MFIs have done with the remaining money they’ve withdrawn from the European banking system… but that’s a story for another day.) This has happened at a significant rate, with a net transatlantic flow from European to US banks that probably totals close to half a trillion dollars in just six months.

If you’re wondering exactly who has been the first to lose confidence in the European banking system, look no further. It seems that at the forefront is the European banking system itself.

Go Read the Whole Things

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Q4 2010 Flow of Funds: Household leverage down, wealth effect dead, and equities surge

The Federal Reserve released the Q4 2010 Flow of Funds Accounts for the US. On the household balance sheet, net worth (total assets minus total liabilities) was estimated at $56.8 trillion, which is up $2.1 trillion over the quarter. Notably, household net worth has increased $6.4 trillion since the recession’s end (Q2 2009). Moreover, personal disposable income increased another $918 billion over the quarter, which dropped household leverage (total liabilities/disposable income) 1.1% to 116%.

Personal saving as a percentage of disposable income rose markedly in Q4 2010 to 10.9% (based on the BEA’s measurement of saving using flow of funds data – see Table F.10, lines 49-52).

The chart above illustrates the the wealth effect – the wealth effect is the propensity to consume (save) as wealth increases/decreases. In the Flow of Funds data, this is best approximated by the ratio of net worth (wealth) to disposable income. In Q4 2010, wealth rose 0.15 times disposable income to 4.9, while the saving rate surged 6 pps to 10.9%.

I conclude from the near-term times series illustrated above, that the wealth effect is very weak, and the incentive to save outweighs the desire to consume one’s wealth. Better put: households are increasing consumption, but that’s due to increased income not wealth.

Of note, since 1997 the volatility of household net worth to disposable income is near 2.5 times that which preceded 1997. Households are fed up; and at least for the time being, the positive wealth effect may be effectively dead.

As an aside, I put something out there: the ‘measure’ of saving is becoming increasingly unreliable. Spanning the years 2008-current, the average discrepancy between the Flow of Funds measure of saving and the BEA’s measure of the same definition of saving (the NIPA construction) is more than 2 times what it was in the 2 years leading up to the recession. This is worth more investigation; but historically, the FOF measure (the change in net worth) has been more reliable.

Breaking down household assets from liabilities, you see what’s driven most of the cumulative gain in net worth: financial assets, which are up near 16% since the recession’s end. During the recovery to Q4 2010, pension fund assets are up 22%; mutual fund holdings gained 32%; and here’s the Fed’s baby, corporate equities (stocks) surged 41% (and more, of course, since this data is truncated at December 2010). Credit market instruments are up 6%.


The asset gains outweigh the drop in liabilities, as mortgages and consumer credit have dropped near 4% and 2%, respectively, since the end of the recession. Consumer credit is making a comeback, though, growing 1% over the quarter, while households continue to reduce mortgage liabilities.

I will comment sometime over the weekend or next week about corporate excess saving, which also is constructed using the Flow of Funds data.

Rebecca Wilder

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Heavy Flow (not an iPad post)

Was 2009 a great year to be a bank? The headlines all say so. (The 140 U.S. banks that were closed by the FDIC last year may disagree some.) But, as Isabelle Kaminska of Alphaville notes, very little of the gains posted for last year came from anything related to talent:

Deutsche Bank reported net income of €5bn for the year 2009 on Thursday, compared to a €3.9bn loss in 2008.

This, we would say, is a pretty impressive turnaround in anyone’s business….

Deutsche attributes much of that growth to the successful re-orientation of its business towards customer business and liquid, ‘flow’ products. While it’s not broken out within the results, we’re willing to bet that a large slice of that re-orientation was therefore focused on managing flow emanating from the group’s ever growing synthetic exchange-traded-product and foreign exchange businesses — both of which happen to do very well when spreads are wide, and volatility is high.

When I first started working in the investment side of the banking industry, 20-some years ago, the traders and marketers were especially careful to distinguish themselves from the “retail” side of banking. Indeed, the retail bankers were described as “9-6-3” people: lend at 9%, take deposits at 6%, and be on the golf course by 3:00.

Now that that same type of effort is producing all those record profits, is it time to decide that the legendary “management skills” of Jimmy Cayne, Vikram Pandit, and Neutron Jack (who turned GE from a products company into a finance company) might not have been all that different from that of a polyester-suited small-town bank manager?

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US Flow of Funds: wealth recovery fully underway, China?

by Rebecca Wilder
(crossposted with Newsneconomics)

This week the Federal Reserve reported the Q3 2009 Flow of Funds accounts. The headline indicators show household net worth improving and private debt burden falling.

The private sector – households and firms – is dropping leverage.

Update: This chart has been modified slightly – the leverage level data (highlighted in blue, red, and green) has been updated.
Either by default or by growing saving, the private sector is de-leveraging. According to the D.1 table, households and nonfinancial businesses dropped debt a further 2.6% q/q annualized, while financial sector debt fell another 9.3%. However, total debt (of the domestic nonfinancial sector) grew 2.8%, as the federal and state and local governments grew debt 20.1% and 5.1%, respectively.

Household wealth grew $2.7 billion trillion for a cumulative gain of $4.9 billion trillion since wealth hit a cyclical low in Q1 2009. To put this gain in perspective, household net-worth dropped $17.5 billion trillion from Q3 2007 to Q1 2009, 3.5 x the recent gain. Wealth to disposable income, a statistically significant factor of the personal saving rate, rests right around it long-term (1952-1007) average, 4.9.

The chart illustrates the wealth-effect as the ratio of net-worth to disposable income. The direct and adverse impact of the wealth loss on consumption probably peaked last quarter; however, the lagged effects are ongoing.

Notice that the ratio shifted discretely in the 1990’s, not coincidentally when China’s current account surplus took off.

Most likely, the wealth to personal income ratio has mean-reverted, and will not rise back to its 5.7 1997-2007 average. A necessary condition is that global portfolio flows rebalance – i.e., China saves less and the US saves more. However, this will not happen tomorrow – de-leveraging is a process that takes years. The increase in international saving (i.e., falling current account deficits) will take some time, and by definition includes the general government eventually dropping its debt burden. Not to mention the political rhetoric and growing trade barriers suggest that a long-term economic shift is a ways off.

Rebecca Wilder

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Lender of Only Resort?

Ken Houghton, having realized there is still a Commercial Paper market, looks at one implication of it.

One of the things that gets ignored in all the fussing about government debt is how small it is by comparison to corporate debt.

The shortest-term debt, Commercial Paper, can be very interesting. With a maturity that is by definition nine months (270 days) or less—and often for financial institutions overnight, for others rolled over weekly—Commercial Paper can be the lifeblood of an institution.

For Financial Institutions, it’s even more extreme. The prime example is Drexel Burnham Lambert, which failed in large part due to its CP being downgraded, leaving it to turn to the Fed as its Lender of Last Resort. Wikipedia tells the story, using James B. Stewart’s Den of Thieves as its source:

Unfortunately for Drexel, one of first hostile deals came back to haunt it at this point. Unocal’s investment bank at the time of Pickens’ raid on it was the establishment firm of Dillon, Read—and its former chairman, Nicholas F. Brady, was now Secretary of the Treasury. Brady had never forgiven Drexel for its role in the Unocal deal, and would not even consider signing off on a bailout. Accordingly, he, the SEC, the NYSE and the Fed strongly advised Joseph to file for bankruptcy. Later the next day, Drexel officially filed for Chapter 11 bankruptcy protection.

Financial Institutions live and die by their CP sales. Or at least they did before the Greenspan Put. Here’s a chart of Domestic Financial CP Outstanding and Excessive Reserves over the past twelvemonth:

It certainly appears that the banks are using their “excess reserves” to make up for an inability to issue Commercial Paper in the amounts they did before. Perhaps the Fed Governors who are talking up recovery (h/t David Wessel’s Twitter feed) should wait until the debt markets strengthen a bit as well.

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Flow of Funds Accounts: some are deleveraging, while others are not

by Rebecca

The Federal Reserve released its quarterly Flow of Funds Accounts, and the message is crystal clear: the private sector is dropping debt burden, while the public sector is growing it.

Quarterly private sector debt growth, households + nonfinancial business + finance, has been slowing or negative since the second half of 2007. In contrast, federal and state and local governments are selling debt like it’s going out of style, with 28.2% and 8.3% annualized debt growth in the second quarter of 2009.

It is no secret that the private sector is unwinding debt, but to what end? 100% of income? – 110%? – Or 65%?

According to Reuven Glick and Kevin J. Lansing at the San Francisco Fed, Japanese households dropped their debt burden to 95% of disposable income. If US households were to follow a similar path, then the debt cycle would be complete in 2018. An excerpt from the article:

After Japan’s bubbles burst, private nonfinancial firms undertook a massive deleveraging, reducing their collective debt-to-GDP ratio from 125% in 1991 to 95% in 2001. By reducing spending on investment, the firms changed from being net borrowers to net savers. If U.S. households were to undertake a similar deleveraging, their collective debt-to-income ratio would need to drop to around 100% by year-end 2018, returning to the level that prevailed in 2002.

There is deleveraging still left in the pipeline, but one cannot say that the Japanese experience foretells the path of US debt. The economic agents, their propensities to save, and underlying economic fundamentals are different: 100% debt to disposable income in Japan may not be the equilibrium level in the US. Unfortunately, though, nobody can tell you what the level is…just something less than 125%.

The path of saving (paying down debt)

The US economy has suffered a precipitous drop in consumer demand, as the marginal saving rate surged. Going forward, higher saving (the average saving rate) does not preclude income and economic growth per se, but increasing saving (the marginal saving effect) can.

As wealth effect ratios stabilize – the chart to the left features the wealth effect as household net worth/personal disposable income – I believe that household saving will stabilize and consumer spending will grow with income.

Admittedly, though, the lag structure of the recent anomalous wealth effect is not known, and the strong marginal effect on saving might continue (i.e., the saving rate grows, as in the San Francisco Fed paper). To be sure, the labor market has dropped wage growth to record lows (see Mark Thoma’s post here), and Q2 ’09 annual disposable income growth was negative (a first since 1951). Not good for contemporaneous saving and spending growth.

The next four quarters, or the early period of recovery, will be critical in setting the stage for income growth. The recovery is expected to be weak, with the consensus GDP growth forecast around 2.4% in Q4 2009. But given the precipitous decline in output, even a 5% annualized quarterly growth rate during the early recovery would be rather “weak”. There’s room for an upside surprise as financial and housing markets stabilize.

Rebecca Wilder (if you are interested, I listed additional Flow of Funds charts here)

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