In an earlier post titled “CDS rates, What Is The Thermometer Telling Us?” we said:

Sovereign default rates are moving higher across the globe. It underscores a concept we detailed in a recent Commentary and Conference Call, namely the credit crisis was never solved. It was transformed from a reckless private sector borrowing binge to a reckless public sector borrowing binge.

Let us explain:

In the wake of the credit crisis we often talk of deleveraging.  But how much has really taken place?  The latest Flow of Funds data can help shed some light on this.

The first chart shows total credit market debt in blue on the top and its four-quarter rate of change below.  As of Q3 2009, total debt stood at $52.617 trillion, growing 1.05% from one year earlier.

<Click on chart for larger image>

Deleveraging requires negative debt growth.  Since the chart above shows total debt growth of 1.05% over the last year, this is not deleveraging.  To be fair, it is the lowest growth since this series began in 1952, but it shows no sign of deleveraging.

Breaking down the series above, the next chart shows private credit market debt in the same format. Private credit is the total credit measure shown above minus Treasury, municipal, agency (including GSE-guaranteed MBS) and foreign debt.

<Click on chart for larger image>

This chart shows that the private sector is deleveraging.  The total level of private sector debt is 3.80% lower than a year ago and negative for the first time since this series started in 1952.

The next chart further breaks down private sector debt, showing financial and non-financial private debt. We find that virtually all the private sector deleveraging comes from the financial sector (blue lines), down 10.47% in the last year.  The non-financial sector (red lines), which has borrowed more than 3 times times the financial sector,  has barely deleveraged, down only 1.42% in the last year.

<Click on chart for larger image>

The final chart below shows total government debt.  This includes Treasury, agency (including GSE-guaranteed MBS) and municipal debt.  It is booming and currently stands 9.81% higher than it did 1 year ago.  During the height of the crisis, Q3 2008, government debt levels were booming ahead at an 11.57% pace, a 20-year high.  This is the opposite of deleveraging.

<Click on chart for larger image>


The “Great Recession” has essentially only resulted in deleveraging of the financial sector. The overall levels of debt are still rising, thanks to a very modest deleveraging of the non-financial sector and a big releveraging of the government sector.

Was the only problem that the financial sector was too leveraged?  If so, the Great Recession returned the markets to sane debt levels.  If not, then the government releveraging has prevented the correction and deleveraging needed to put the credit crisis firmly behind us.  We fear the latter may be closer to the truth and the credit crisis is only partially complete.  The next major deleveraging will occur in the government sector.

Is this what widening sovereign CDS rates are telling us?

Category: Bailouts, Credit, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Is The Second Leg Of The Credit Crisis Starting?”

  1. ashpelham2 says:

    If you are correct, then where does the money go next? If sovereign debt is blowing up, where’s the next flight to safety? JFG coffee cans?

  2. Steve Barry says:

    Jim, do you have any data as to how much excess credit we have globally over and above the “sane” level you talk about? My rough calculation is $50 Trillion.

  3. Moss says:

    The game will be in determining what the pecking order of sovereign debt ‘repricing’ will be, which currencies will get blasted and where will everyone run. The market is saying the Club med group is first in line, the euro gets slammed the dollar goes up and capital flies to either the US, Asia or select Latin American countries.

  4. [...] Is sovereign debt the second wave of the credit crisis?  (Big Picture) [...]

  5. But isn’t it the lesser of evils, given the current environment, for public (government) re-leveraging to occur while private and corporate de-leveraging occurs, as this piece suggests is occurring now?

    I hope this is not taken too far out of context but Barry just posted today, saying, “Counter-cyclical spending means that governments should watch the budget carefully during the good times, but spend spend more freely during the downturns.”


    Of course, we still face the reality that politicians are the drivers of fiscal policy….

    “One of the penalties for refusing to participate in politics is that you end up being governed by your inferiors.” ~ Plato

  6. stevenstevo says:

    Government deleveraging will occur if/when the fed decides to start contracting (i.e., buying back T bonds). Whether that will happen, or when that will happen is a huge unknown. That will depend upon about 8,000,000 factors, many of which will effect some of the 8,000,0000 factors that effect household consumption/saving. Deleveraging itself is not a good sign for the economy. If one thinks our debt levels have gotten out of hand, then fine, but realize that such a viewpoint means we’re screwed–reduced consumer spending will drag on growth, and it will take 10 years at least before we can reduce debt significantly. Not saying we don’t need to reduce our debt levels–just saying if it’s true that we do, then we’re in for some real pain for 10-15 years. A more optimistic outlook would be that economic growth picks up, driving up discretionary income, which will reduce debt burdens and possibly decrease them.

    The point is: if you think we’re headed for a period of deleveraging, this is essentially the same thing as saying you think we’re headed for a period of stagnant economic growth. You cannot really have growth while deleveraging. Growth requires capital spending. Capital spending requires, well, spending. If there was enough cash to fund capital investments, then, well, no need to deleverage in the first place. Thus, financing is required, but that would increase leverage.

    The Fed will not substantially “deleverage” until growth picks back up and inflation bears its ugly head.

  7. boatman says:

    currency crises and soveriegn debt/failure will drive us all to GOLD… that we’ve acted like barbarians,seems logical to resort to it……how anyone cannot see this is the unraveling of paper money promises is beyond me……