On Turning a Mountain Into a Molehill

By Annaly Capital Management.

We’ve made no secret of our love for the Federal Reserve’s Z.1 Flow of Funds report. The only thing more amazing than the impressive volume of data in the release is the lack of coverage it receives by the financial media, who basically report the directional move in household net worth (it rose by $1 trillion to $54.6 trillion), and then move on to something else. We suppose the rest of the 125 page report doesn’t make for very entertaining television.

The household sector did improve during the quarter. Total assets rose as increases in the value of credit market instruments and equity investments offset a decline in real estate assets. Household liabilities fell, including drops in both mortgage debt and consumer credit. The $1.06 trillion rise in household net worth represents a 2% increase over the previous quarter, though it is still more than 15% below its 2007 peak of $65.9 trillion.

There are a few graphs in particular that we always have queued up, ready and waiting to be updated on Z.1 release day. Our favorites tend to focus on total credit market debt outstanding. The first of these looks at total debt to GDP, which seems to be starting a potentially long deleveraging process.


In order to get this ratio back to 300%, given a constant GDP, total credit market debt needs to fall by more than $8 trillion. Or we could just grow our way out of it. At 6% nominal GDP growth and flat credit market debt, it would take until the first quarter of 2013 to get back to a 300% ratio. That’s not to say that we think 300% is the correct ratio. If interest rates ever move significantly higher, 300% might be too high.

The next set of charts were originally created in response to the oft-cited assertion that “there is a ton of cash on the sidelines” waiting to support asset prices. First, we look at our favorite measure of cash, M2 plus institutional money funds.


At $10.6 trillion, that is a lot of cash. However, how does it look in relation to the amount of debt outstanding that it needs to service? After all, an investor wouldn’t gauge a company’s health by looking only at the cash position on a corporate balance sheet; he would look at “net cash,” or cash net of all debt outstanding. We do something like that in the chart below, which shows cash as a percentage of total credit market debt.


It only took about 450 words and three graphs to have the title of this piece make sense.

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