Mr. Market Miscalculates (The Bubble Years And Beyond)

James Grant, “Mr. Market Miscalculates (The Bubble Years And Beyond)”, National Book Network, 2008; Pages 412
For the past 25 years Grant has published a bi-weekly Wall Street newsletter “Grant’s Interest Rate Observer” from which all of the articles in this book come from. The books articles trace the events of America’s bubble era: from the dot-com boom of the late 1990s to the house-price bubble of the early 2000s to the subsequent worldwide mortgage collapse. The book has many good articles and many very hard to understand (at least for me) articles. It was a hard book to stay focused on as much of it is very much written in the priestly idiom of financiers.

My Notes:

Pg. 106: The American price level registered little net change between 1800 and 1929. Four years after the Crash, the Roosevelt administration put the gold standard, or what was left of it, out of its misery. In 1946, the Truman administration passed an act to mandate full employment. In effect, inflation became the law of the land. In the two decades following the abandonment of the gold standard in 1933, the consumer price index in the U.S. nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy, unleashed from the constraint of gold convertibility, had allowed a persistent overissuance of money. Yet, in 2002 Greenspan felt we were in danger of a deflation. To forestall this supposed crisis, the Fed pushed down the funds rate to a 46-year low.

Pg. 107: Deflation is not quite the opposite of inflation. Grant defines deflation as too few dollars chasing too much debt. Dollars extinguish debt; too few dollars in relation to the stock of debt is the precondition for what, these days, is euphemistically called a ‘credit event.’

Pg. 122: Grant writes to advance the proposition that falling prices are a natural byproduct of human ingenuity. Print money to resist the decline, and the next thing you know, there’s a bubble. Let Fulton harness steam power, Edison the incandescent bulb and more work will be done by fewer hands. In consequence, some prices will fall, some people will lose their jobs and some portion of the world’s capital stock will be cast into obsolescence. By intervening to mitigate the sting of these adjustments, on which it fastened the name ‘deflation,’ the Fed was instrumental in bringing us to the present state of affairs in credit. It’s a funny world when municipal bonds are priced to outyield Treasurys, when the inflation rate overshadows the 10-year Treasury yield and when the triple-A segments of mortgage derivative3s are priced as if for Armageddon. But those are the facts.

Pg. 130: In 1945, Americans owed mortgage creditors just 14% of the value of their homes—the rest, 86%, was theirs in equity. In 1985, they owed 32%. As of the first quarter (2001), they owed 45%, leaving 55% in equity. In 2001 there were people in hot real estate areas who were living on refis of appreciated housing. At the end of the first quarter of 2008, homeowners owed 53.8% of the value of their homes to mortgage creditors, an all-time high.

Pg. 180 (Oct 2006 article): As recently as 2000, just 25% of subprime mortgage issuance was characterized by limited documentation—information submitted, in effect, on the honor system. Only 1% of the market consisted of piggyback loans junior t the first mortgage, and exactly no percent was represented by the interest-only payment option. At last report, 44% was characterized by limited documentation, 31% by piggyback loans and 22% by the interest-only alternative. The outpouring of so-called affordability products has effectively turned homeowners into renters. What they substantively own is not the house in which they live, but rather an option to buy it.

Pg. 381: Benjamin Graham laid out seven criteria for conservative stock selection. A deserving company should have: (1) adequate size, (2) a good balance sheet, (3) 10 consecutive years of net profits, (4) 20 years of uninterrupted dividend payments, (5) a modicum, at least of earnings growth, (6) a P/E ratio no higher than 15 and (7) a ration of price to book value no higher than 1.5:1. They pertained to industrial companies, not to utilities or banks.