Friday, November 9, 2012

US Treasuries, Home Equity and The Real Crystal Ball

Twist and Shout
I was compelled to do this after seeing this post at Illusion of Prosperity.  Sometimes I see a graph and I feel compelled to build upon it, but no graph here just a ledger:
Federal Reserve balance of various US treasuries by maturity along with US treasuries outstanding.  I hope my accounting methods are satisfactory, I did not include non-marketable and TIPS into the calculation.
The Federal Reserve currently has 16.4% of the US's outstanding non-TIPS marketable debt on its balance sheet.  I suspect the Federal Reserve is going to shed all treasuries with 5 years or less to maturity off its balance sheet - building up the 5+ years to maturity as a reserve for when they test their target rate in 2015.
On the Federal Reserve's Dole
The Federal Reserve also has $852 billion of GSE (Fannie, Freddie, Ginnie) mortgage backed securities on its balance sheet.  Prior to the conservatorship in 2009, agency and GSE mortgage-backed pools totaled $5.37 trillion.  I suspect the Fed's MBS balance will grow by $1 trillion. 
Just Like a Stock Market Crash
Remember, from its peak in Q4 2005 to its bottom in Q4 2008, home owner's equity fell $7.27 trillion.  I just don't think there is a quick fix to restore the economy - or to restore all that equity - and I don't think I want one.  It's been 5 years since the credit crunch of 2007 and we are still at 8% U3 unemployment and 15% U6 unemployment. 

Home Equity Loans divided by Home Owner's Equity (blue), and for good measure I turned it into a random gold (red) graph - can't have enough of those.

Looking Into the Crystal Ball
Honestly, I believe the recession was caused by overleveraged households - too much debt, and bad debt at that.  Financially speaking, it was a run on the repo, and what we are now experiencing appears to be a crisis of the repo stemming from systemic risk.  Households cannot effectively take on debt at the pace they did from the late-1990s to the mid-2000s.
What is the Federal Reserve's ultimate plan?  Beats me, but it looks like they are building leverage for when they raise interest rates.  There is an inverse relationship between interest rates and asset prices.  I think everyone realized that back in 2004-2007, same with the 1994 CMO bond market collapse, and same with the Latin American Debt Crisis.  For all those home owners with a mortgage tied into LIBOR (and ultimately the Fed Funds rate), good luck.
Looking Into a Different Crystal Ball

Household debt (blue) and household debt percent change from year ago (red). So it never had a negative year over year change since 1951?
So, I was reading through Robert Shiller's The Subprime Solution (2008) and came across a very, very interesting passage.  This passage was in context to when, in 2005, Shiller was updating his book Irrational Exuberance (2000) and wanted to add a chapter about historical housing market statistics.  His reaction when he asked around about available long-term data:

To my surprise, everyone I asked said that there were no data on the long-term performance of home prices – not for the United States, nor for any country.  Stop and think about that.  If the housing boom is such a spectacular economic event, wouldn’t you imagine that someone would care if this kind of thing happened before, and what the outcome had been?  But, amazingly, nobody seemed interested in what had happened more than thirty or so years ago.  This is at once a lesson in human behavior and a reminder that human attention is capricious.  Clearly no one was carefully evaluating the real estate market and its potential for speculative excess.


  1. "household debt percent change from year ago (red). So it never had a negative year over year change since 1951?"

    Of course not. We think we need credit for growth, and more credit for more growth. So policy is set accordingly.

    Even now: For the last four years everyone has been deleveraging. But what's Bernanke's goal? To get people borrowing more, again!

    1. Looking at it now, the Total Debt/M1 graph is a good illustration that debt is the collection of future income. If the future gets worse (GDP contracts) then debt has to be written off or restructured.

      Debt, traded like a commodity, is therefore subject to the laws of supply and demand. Afterall, there is only so much future income earning potential before inflation gets out of control and destroys an economy.

      I read an interesting quote, in the book Millionare by Janet Gleeson, by the Duc de Saint-Simon who was addressing John Law in regards to the banking system Law was proposing to the French Monarch. Summing it up, he said that an absolute ruler will corrupt the currency, debase it and plunder the economy at the cost of ruining the nation. Hopefully, the United States, with its system of checks and balances is able to avoid such disaster.