Seeker Blog

Yves Smith has assembled data and analysis I’ve not seen elsewhere. I’m not sure what conclusions to draw from this. Will hiding under the bed help?

It no doubt seems absurd to question the idea that deleveraging is underway. We’ve had three heroic central bank interventions, starting in August 2007, to reverse seize-ups in the money markets. The asset backed commercial paper market has been almost in run-off mode. Leveraged buyout loans have been scarce to non-existent. Banks have cut home equity credit lines and credit card borrowing limits. Commercial and industrial loans have fallen. The private mortgage securitization market is a shadow of its former self.

Yet the macro level data, at least as far as the US is concerned, tells a dramatically different, indeed troubling story (click to enlarge):



The chart is admittedly a bit hard to read, but it is prepared from Fed’s Funds Flows through the latest reporting date, which is March 31, 2008. The chart comes courtesy Frank Veneroso’s June 18 report, “Why a Second Wave is Inevitable.” (no online version, but if you ask nicely, I can e-mail you a pdf). The line is Total Credit Market Debt/GDP. As you can clearly see, the steepness of the vertical ascent of the has not eased in the last year or two. If anything, it may have gotten worse.

We will return to discuss the implications of how big the debt level is, but the graph itself should serve to focus the mind. The March 31 level was 350% of GDP. The previous peak occurred in 1933, during the Great Depression, at just under 270% of GDP. Note that the peak was reached due to the start of the rapid fall in GDP taking hold faster than debts were written off, a dynamic not in operation now. So the comparable level to our situation is in fact lower than the 270% peak.

An additional bit of cheery news comes from reader Bjomar: Japan’s total debt to GDP in 1990 was roughly 250% (it took some triangulating among this, this, and this source, his interpolation of corporate debt at 100-140% of GDP, household at 65%, and government at 60%). And unlike us, Japan had a very high saving rate, so its net debt would have been less alarming.

On my recent quick turnaround trip to the West Coast, I had the opportunity to read all sorts of interesting research various readers had sent me that I simply could not get to previously. All of it was useful, but the Veneroso discussion, and particularly his chart, seemed the most unrecognized, underappreciated element of the credit crunch.

Now the story in the first paragraph is not inaccurate. Private sector credit growth has slowed, in fact pretty dramatically in the first quarter. But “slowing growth” and “deleveraging” are two different conditions. Alejandro Neut at Banco Bilbao provides a good overview of the Fed’s funds flow data for the first quarter of 2008:

Credit continued to decelerate in the first quarter of 2008. Total debt of the domestic nonfinancial sectors grew at a seasonally adjusted annual rate of 6.5% (1 pp lower than in the previous quarter and the lowest rate since 2001). Even when the reduction in debt growth was not as pronounced as the one in 2007Q4, when debt eased from 9.1% to 7.5%, the decelerating trend shows no signs of abating. This bleak assertion is based in the yet strong deceleration of households’ debt, segment which remains the main driver of the current downtrend (households’ debt grew a meager 3.5% compared with the previously seasonally annualized growth of 6.1% in the previous quarter). Debt in almost all sectors grew at a lower pace than anytime during 2007. The only exception was the federal government’s debt, which grew at an impressive annualized rate of 9.5%.

Business debt continued to expand at a healthy pace Business’s debt grew 10.8% yoy. With interest payments at historical lows (relative to profits) debt growth in corporate America was robust. This explains why businesses have been shifting the means to finance itself, from bond issuance to bank loans. But risks are growing: the financial gap remains at a high level, indicating the need for external financing in order to keep current operations.

Read the whole thing.