US financial sector boom threatens repeat of 2008 crisis
0US first quarter flow of funds data have revealed that to maintain 4% nominal expenditure growth, and short of income growth, households have been reducing their savings and re-leveraging their balance sheets.
This fall in household savings has then allowed the US profit share to surge, but companies did not use the proceeds to generate new capital expenditure or even much new employment, but rather they devoted the resulting funds, and a large amount of borrowed funds, to intense levels of so-called zaitech.
Meanwhile, the US financial sector essentially expanded at its fastest pace since the onset of the global financial crisis, largely by using the same mechanisms that it had done five or six years earlier – acquiring Government Sponsored Enterprise debt and Credit Default Swaps rather than Collateralized Debt Obligations, but the basic process has been the same.
Meanwhile, the US fiscal and current account deficits have not been addressed, far less resolved.
Based on the flow of funds data, it is easy to see why headline US GDP growth has been so disappointing relative to consensus expectations, but arguably the real story in the data is that the financial sector has been booming and this has obscured the short comings, unsustainable features and contradictions within the real economy, just as was the case back in 2006.
As became apparent, the economy in 2006 had poor foundations, and was overly dependent on the premise of prosperity created by the activities and excesses of the financial sector’s activities. As we know, when bond yields increased in 2007, the system was challenged and crumbled, but this time it may be that it is falling bond yields that lead to disaster because lower bond yields imply more expensive collateral, and some would-be lenders potentially drop out for regulatory reasons. The demand for high quality collateral will only rise as Euroland’s crisis persists and deepens, and the ability of the financial sector to mask or offset the soft and compromised condition of the real sectors will itself be weakened.
The next few months will be challenging as the Federal Reserve Board attempts to sustain both the real economy and the financial sector, despite increasing external and domestic threats. Domestic challenges will include both the so-called ‘fiscal cliff’ and also increasing regulation.
Not to put too fine a point on it, if the Fed succeed, we could see another retreat from the brink, as was achieved in the second half of 2006, with a strong rally in risk markets. To achieve this outcome, one of the challenges for the Fed must be to support financial sector credit growth not by cutting interest rates but by finding more collateral for the system to work with. Those seeking such a rally should therefore look for such measures rather than hoping for an early breakthrough in Euroland politics.
And if the Fed fail to achieve this delicate balancing act, we could see a repeat of the experiences of 2008. This not alarmist, just realistic – we have much more data and in depth analysis of US flow of funds. Ask if you want!
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
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The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
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