Saturday, August 18, 2007

The Rabelaisian Growth of Financial Debt

The growth of financial sector debt in the US economy has been spectacular. The percentage of such debt to GDP has been growing exponentially while non-financial corporate debt has been steady for decades, as can be seen from the chart below (click to enlarge). Financial sector debt is that which is assumed by banks, S&L's, GSE's, insurance cos., brokers, funding companies, ABS special purpose companies related to mortgage pools, etc. In just 10 years this debt went from 60% to 110% of GDP, clearly showing how leveraged such borrowers have become relative to the US economy. It is also an indication of what I call the "financialization and assetification" of the economy.

Data: Federal Reserve

Of course, debt is not necessarily bad - it all depends on what you do with it. If it is invested in long term infrastructure, plant and equipment and other such economic and productivity enhancements, then debt can be very beneficial. But if debt is created to leverage the "manufacture" of even more debt and speculation in other assets (e.g. margin and LBO debt, debt to fund stock buy-backs, CDO-squared and -cubed, hybrid CDO's, CLO's, CPDO's and ABCP's), then this type of borrowing can be extremely dangerous to the underlying "real" economy. We are currently getting a taste of this: essentially what is happening right now is the inability of the "real" economy to service all this debt piled on it, out of "real economy" earnings.

In many ways, the US has become an economy that manufactures, packages, ships, exports, markets, trades, services and promotes one product: financial sector debt - in all of its permutations and variations. The related products are hedge funds, LBO companies and private equity concerns, all of which create the demand for and depend on the consumption of an uninterrupted supply of fresh debt, grossly mis-labeled as "liquidity".

If Rabelais was alive today he might have included a chapter about the feeding habits of such institutions in Gargantua.

Gargantua Feeding On Hedge Fund Liquidity


Anonymous said...

so... are we going into a recession?

Hellasious said...

Yes, I believe so.

jason b said...

when the party is over, I thought the FED was supposed to take the punch bowl away. They are walking around the party shoving it under peoples faces.

covered wagon said...

another great post. elevated far and away above the blog rabble. keep 'em coming!

Anonymous said...

do you think there's anything else the FED or anyone(singular entity or a collective of entities) else could do to salvage the situation?

Anonymous said...

n what abt china? they seems to be relatively unaffected, at least at the moment.

Hellasious said...

1. Can anything be done to salvage the situation?

The problem, in nutshell, is there is too much debt vs. the underlying economy, which cannot generate enough operational income to service and repay it, so it keeps (kept) pumping up asset prices to "collateralize" it. Only two ways out of this mess: cancel debt and/or raise the earnings. These would take major political decisions and policy revisions, not just a Fed action. We are way beyond that.

2. China: They think they are inviolate, just like the Japanese in 1988-90. I believe we are close to the creation of a bubble of colossal proportions there and I don't mean just their stockmarket. Their mfg. and commercial real estate overcapacity must be simply enormous viz. final demand.

...and thank you all for your kind words.

Anonymous said...

The Fed ( and other CBs with political agenda ) is just buying time for the financial institutions caught in this credit crisis and meltdown by extending last resort funds and hoping to pacify jittery investors by lowering the discount window. Neither will be effective in the long run. The market will have to work out the excesses through a deflation of financial and real estate asset prices. IMHO, any correction of inflated asset prices by less than 30% will be insufficient. Even then , given the globalised nature of the problem and the attendant negative effects on economic growth and confidence I doubt that the recovery will be soon..The golden age that is being predicted by the wise one and son will well be a mirage!

Anonymous said...

I am very concerned at this point. This Federal Reserve has been at war with my morals and my savings for a good part of a decade. The last 5-6 years has been the worst of it all. How can I continue to remain in USD's, if this entity is hell bent on destroying the underlying currency to keep asset valuations puffed up and debt from being repudiated? Certainly, if this private banking cartel begins slashing rates down to 1% again, I will have to repudiate the underlying currency for safer stores of value. Does this make any sense at this point in time?

John said...


Excellent post as it begins to bring out the fictitious nature of so much of what most assume to be capital. Historically, such super abundance of claims was, for the main, destroyed during the periodic recessions but, as you know, this has hardly been the case over the last decades though I would have to say that, at least from the so-called 'peso crisis' there have been numerous warnings.

Excellent post since it does not treat the real and financial as barely related spheres but recognizes their interpenetration and that in the last instance the real is determinant, something that many seem to have either forgotten or never known.

China, yes, given its export dependency, insufficiently developed internal market and what already appears an overproduction of means of production, I can really see no way for it to escape what at this point I expect to be another more/less synchronized global crisis.

Anonymous said...

what's your advice for investors?

Hellasious said...

Re: Advice to investors

I firmly believe that investment advice must be provided on an individual basis. Everyone's particular needs are different and what may be perfect for one person may be terrible for another.

However, I can say this: I think that for the foreseeable future, conservation of capital will be much more important than return on capital.


Bart JP said...


You do have a great blog here.

I just want to clarify a point with you. Is this gross or net debt to GDP ratio?

Hellasious said...

Re: gross or net debt

I'm not sure what you mean by gross or net debt. This is straight from the FRB's Z.1 release, "Credit Market Debt Outstanding" table. Some types of financial debt may be counted twice in the figure of $46 trillion for the total debt of the US (e.g. mortgages get turned into MBS and get counted twice, but not within the financial sector debt itself.)

Thank you for your kind words.


Bart JP said...

My point about gross or net is to clarify if there is double counting. Is the financial sector debt reported simply a total of balance sheet debt reported by companies. If so, there would be double counting. By net debt, I loosely meant offsetting balance sheet debt figures with asset valuations to get some sense of the net position of companies. I think the figure might be a lot less alarming.

Hellasious said...

Dear Bart,

Financial cos. assets are essentially debt (loans, bonds, etc.), so no, there is no double counting. I believe the Fed does not just add up the balance sheet liabilities to come up with its figures. Instead, it adds up the debt issued and outstanding. For example, if a mortgage securitizer issues a CDO that is counted. Or when FNMA issues an MBS product, that is additive to debt.



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