When we last updated on the size of the shadow banking system, the financial "system" that is far more important to the economic prosperity of the US economy than the traditional liabilities held by conventional banks, we observed that after declining for 9 consecutive quarters, having hit a peak of $21 trillion in 2008, the shadow banking system had reached an inflection point and had posted a very modest increase at around $16 trillion in total liabilities in the third quarter of 2010. Well, following yesterday's Z.1 release, it seems the bulk of the data was revised, and it appears that not only was last quarter's upward pre-revision data a fluke, when in reality it was another decline of $191.7 billion, but the Q4 data further reinforced the negative trend, with shadow liabilities declining by an even greater $206.4 billion. The components responsible for the decline were ABS Issuers whose liabilities declined by $94 billion, securities loaned by funding corporations declining by $40 billion and lastly repos, which dropped by $79 billion. In other words, speculation that the Fed had achieved its goal of stimulating an organic reflation in the shadow banking system at which point it would be able to end QE and hand off releveraging over to the private sector were premature, and recent data confirms that the Fed has no choice now but to continue with its quantitative easing process, as it does more of the same: take capital from the public sector and proffer it to Primary Dealers in an attempt at ongoing asset reflation, which will, the theory goes, be matched by a comparable hike in liabilities.
So far this theory has been a massive disaster with 11 consecutive quarters of shadow banking liability declines. And where it gets far worse, is that after 5 consecutive increases in traditional bank liabilities which hit a record $13.1 trillion in Q3 2010, this number declined by $231 billion in Q4 to $12.8 trillion. Thus the combined move in Shadow and Traditional Banking liabilities was a whopping $438 billion in Q4!
Unfortunately, while events from Japan this morning may or may not be a catalyst for further QE, the biggest clue as to what the Fed will do is in the charts below.
Shadow banking subcomponents:
Sequential change in shadow banking liabilities:
Combined shadow and traditional bank liabilities:
Sequential change in shadow and traditional bank liabilities:
Botton line - Bernanke has once again failed to spark a "virtuous leveraging cycle" even with QE2, which after all is the fundamental goal of the Fed, far beyond even getting the Russell 2000 to 2000. Which means that the Fed will have no choice but to continue "printing" money, and monetizing bonds, as it (in conjunction with the Treasury of course) continues to be the only incremental source of leverage, and thus money, for the world's biggest economy.