Mr Market Miscalculates The Bubble Years And Beyond
By James Grant
Axios Press, $22
James Grant’s Mr Market Miscalculates may well be the most perceptive book on the current financial crisis yet published. What is most impressive is that almost all of it was written years before the crisis finally struck in July last year.
Grant’s views on the markets are well-known and consistent. A strong critic of the decision to take the dollar off the gold standard in 1971, he has used Grant’s Interest Rate Observer, which he founded 25 years ago, to criticise the money-printing policies of the Federal Reserve. He has earned a steady and loyal following.
As for the stock market, he has been an unrepentant bear. “Grant’s has never – not in 25 years – had a constructive thing to say about the S&P 500,” he boasts in a foreword. It would be unfair, however, to label him a one-dimensional “perma-bear” or doom merchant. He draws his title from Benjamin Graham, the investment theorist, who coined the term “Mr Market” in the 1930s. Thanks to Mr Market’s irrational behaviour, Graham said, it was possible for opportunistic investors to make money. Grant paraphrases Mr Market’s attitude thus: “Price is never an object; he just wants in, or he wants out. You, the sane one, could get rich just by availing yourself of the opportunities served up by your unbalanced partner.” Grant does, therefore, see ways in which investors can make money from the stock market. The essays in the book show how easy the opportunities were to spot.
Of most interest will be the chapters entitled “Mr Market Buys a House” and “Mortgage Science Projects”. His prescience is alarming. In August 2001, when many were preoccupied by the fall-out from the tech boom and the risk of deflation, he devoted a column warning that US house prices were up 8.8 per cent from a year earlier. “What could explain a bull market in a non-earning asset in a non-inflationary era?” he asked. “Ample credit is the first answer, low interest rates the second. An overly narrow definition of ‘inflation’ is the third.”
He also warned that Fannie Mae and Freddie Mac had extended their lending by more than 12 per cent over the preceding year and that Americans owed 45 per cent of the value of their homes, up from 14 per cent after the war. To end the column, he disparaged comments by Alan Greenspan, then the chairman of the Fed, that rising house prices were “a very important contributor to the American economy”, warned against the “day trading of houses” and said that “the American house market can be described as speculative”. This is exactly what we should have been worrying about in the summer of 2001.
As the housing boom went on, he warned against non-amortising mortgages (“rope for the neck of the homeowner”). As early as 2004, he wrote about how the 1 per cent Fed Funds rate, with which the Greenspan Fed battled the perceived threat of deflation, had “transformed the borrowing patterns of the clientele of the northeast region of Washington Mutual”. WaMu has now passed into history as the biggest US bank failure on record.
In that region, Grant found, the proportion of customers using the lethal “Option-ARMs” – where payment of principal could be deferred and interest rates could be adjusted upwards – had leapt from 5 to 40 per cent. A WaMu official told him that customers were now using mortgages “to leverage their home as a financial asset”.
“When the Fed lifted the funds rate in 1994, it caught out the hedge funds and interest rate speculators,” warned Grant. “When it raises the funds rate next time, it will catch out Mr and Mrs America.”
There are many other uncanny examples of prescience in his diagnosis of the conditions that led to the current crisis. His trademark clarity of thought and of expression are there throughout. So, thankfully in an analyst who is generally pessimistic, is a crackling sense of humour.
Many Grant devotees who buy this book might well be disappointed that there is not more original material. Apart from a well-written foreword and postscript, the entire book is made up of columns put into thematic chapters. One irritating flaw that could have been corrected in the editing process is that many refer to accompanying graphics not published in the book.
Mr Market really is a manic-depressive and it is often easy to see where he is going wrong. That means that he gives others the opportunity to profit. Grant spotted those opportunities when it was still possible to make a lot of money from them. If Grant could see what was happening this clearly, and warn of it in a well-circulated publication, how did the world’s financial regulators fail to avert the crisis before it became deadly, and how did the rest of us continue to make the irrational investing decisions that make Mr Market behave the way he does?
The writer is the FT’s investments editor