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The Banking System Is Both Too Big and Not Big Enough

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It's too big in the sense that the capacity to make loans far outweighs the demand for credit, yet it's not big enough to accommodate the demand for liquid savings.

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Going into the weekend I wanted to write about data that showed household net worth was the highest since 2007, and more specifically, examine how we got back to that $66 trillion level. Then on Friday with news that the US Treasury had requested information of all 10-year note holders above $2 billion in assets, I thought about speculating on what was behind the recent 10-year note repo squeeze. I came to realize they were both part of the same story.

When the Fed's Flow of Funds data was released two weeks ago, the focus was not on how many US Treasuries the Fed held as a percent of the outstanding stock, as I wrote about last week in Quantitative Easing: The Greatest Con Ever Sold, but rather about the rise in household net worth to 2007 levels. I wanted to look under the hood and see what exactly caused that increase in "nominal" wealth and what asset allocation trends implied about investor behavior.

Household Net Worth – Financial Assets



In 2006, the first of the baby boomers turned 60 and household net worth was $65.6 trillion. The Flow of Funds breaks down between financial (investments) and non-financial (real estate) assets further breaking down those two assets classes. In 2006 households had 75% of the net worth allocated in financial assets which include savings deposits, bonds, stocks, mutual and pension funds. In 2006 those subsets were allocated as follows: 14.33% in savings deposits, 9.48% in bonds, 19.73% in equities, 8.41% in mutual funds and 25.95% in pension fund reserves equaling 77.9% of household financial assets.

Since 2006 household net worth has climbed by only $455 billion with the value of non-financial assets falling by $4.4501 trillion and financial assets growing by $4.939 trillion. At the end of 2012 financial assets represent 82.32% of net worth vs. 75% in 2006.

If you listened to the Fed you would assume that their easy-money monetary policy is responsible for the growth in net worth. However between 2006 and 2012 the allocation to corporate equities only grew by $12.7 billion. The category that carried the biggest share of the increase in net worth was liquid deposits, which at $2.2 trillion accounted for 45% of the total growth in financial assets. The other two allocations with large increases since 2006 were mutual fund assets, which accounted for $1.1 trillion or 23% of the growth with pension reserves increasing by $1.2 trillion accounting for 25.71% of the growth.

Mutual and pension funds obviously benefit from rising asset prices but they also benefit from the consistency of paycheck contributions still representing a form of increased savings. However it's the increase in liquid savings deposits in a zero interest rate environment that is the real outlier.

To demonstrate the changing trend you only have to look at deposits and equities. In 2006 households held $9.75 trillion in corporate equities and $6.8 trillion in deposits. Today households have increased deposits to $9.045 trillion while equities have maintained roughly the same value of $9.7 trillion. The $455 billion household net worth increase isn't due to growth in asset prices as much as it's due to growth in savings. Contrary to what Fed policy would have you believe, household net worth is not growing because of zero interest rates and QE, it's growing despite of it.

I believe this is the inevitable cycle of baby boomers increasing their savings to finance retirement. We can look at the boomer financial evolution in three stages, investment, consumption and savings all dominating US economic and market trends. In 2000 the market saw the top of the baby boomers' investment cycle. In 2008 the market saw the top of the baby boomers' consumption cycle. Now we are on the other side of the investment and consumption cycles as we witness the baby boomers' cycle of savings.
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