Posted December 11th, 2008
|(left to right) Polytechnic Institute of NYU President Jerry Hultin, GMO Chairman Jeremy Grantham and Polytechnic Institute of NYU Trustee Jeffrey Lynford.|
Conventional wisdom would have you think that the U.S. was blindsided by the housing crash that precipitated the dramatically sharp economic downturn of recent months.
Jeremy Grantham, chairman and co-founder of the investment management firm GMO, which manages $150 billion in assets, would have you think otherwise. “This is the most widely predicted surprise in finance,” said Mr. Grantham on December 2 as he delivered the 11th Annual Lynford Lecture at Polytechnic Institute of NYU. “Almost everyone we deal with saw this coming.”
Housing and “Greenspanian magic”
Mr. Grantham credits over stimulus of the housing market after the 2000-2001 dot com bust for the break in the housing bubble. For 100 years, the U.S. housing market’s diversity kept it flat overall. “It would bubble in Florida, but crash in Chicago,” said Mr. Grantham. That was until what he calls “Greenspanian magic” lead to “massive stimulus, massive moral hazard, and massive resistance to equities.”
The government, says Mr. Grantham, subsidized debt, was “begging you to borrow,” and encouraged risk. And while people learned from the dot com bust “not to buy overpriced stocks; they didn’t learn not to buy overpriced houses.”
The good news: “The housing market has gone back, two thirds of the way to fair value; most of the pain is behind us,” said Mr. Grantham. He cautioned though that the market still has a 10 – 15% decline ahead of it.
The bad news: the ripple effect into other markets is a long way from over.
Career risk: “the only thing you need to know about the stock market”
The worse news: like the housing market’s bust, many finance professionals foresaw the credit crisis and the bearish market we now face. They didn’t, however, act in their clients’ best financial interests to protect, or at least minimize the damage.
“This was the biggest con-job in history,” said Mr. Grantham. “It was the biggest betrayal of trust in the history of our business.”
According to Mr. Grantham, those who believed in the data that pointed to a majorly bearish market, “didn’t have it in their job descriptions to get to you.” Why? Because bearishness is bad for business. “You cannot sell stocks by being bearish.”
Why didn’t companies worry about giving poor investment advice? There, on a slide projected 10 feet high on the stage was Mr. Grantham’s answer: They We’re Managing their Careers, Not their Client’s Risk.
“This is all you need to know about the stock market,” said Mr. Grantham. “Career risk is what runs the institutional business.”
As Mr. Grantham explains it, it is worse for investment managers to be different than to be right. So instead of a great swell of warnings about the looming credit crisis, which, remember would be bad for business, there was a swell of silence. “Wrong in company, you’ll never lose your job,” he says. And, “if everyone is protecting their career by not being different it creates the most amazing herding mentality.” Herding, he says, “is overwhelmingly the greatest market inefficiency.”
Big picture numbers: “we thought we were rich; we’re not”
According to Mr. Grantham, most recessions are actually quite healthy: “they take assets from weak hands and redeploy them into strong hands. [But] once in a blue moon you have a wipeout of perceived wealth, a solvency crisis.”
Mr. Grantham explained that the current crisis is a liquidity problem, but “it’s a supremely solvency crisis” too. And in his opinion there have only been two previous solvency crises: the crash of ’29 and Japan’s economic fall in 1989. The current crisis, he says, “is the third and it’s the first truly global bubble and global bust.”
How bad is the damage for the U.S.? Two years ago, the U.S. had $50 trillion in assets and $42 trillion in debt, which Mr. Grantham says, “is dangerously high, but at least it has some decent relationship to $50 trillion.” Once the current crisis bottoms out, Mr. Grantham thinks that the U.S. will be down $20 trillion in assets, leaving it with $26 trillion in un-backed debt, 15 or 20% of which he thinks will be written down.
“We thought we were rich,” says Mr. Grantham. “We’re not. We thought we could retire early, we can’t. Our 401(k)’s and pensions are half what we thought they were. Everybody is getting used to the fact that they’re not rich and they’re doing it fast. It’s as if the entire global economy ran head down into a very thick cement wall.”
Investment, the environment, and the “age of frugality”
Mr. Grantham began his lecture by discussing the environmental impact of global population and wealth growth, saying that “it is utterly inconceivably unsustainable to grow the population at 1%” – roughly the rate of growth in the 20th century – “or to grow wealth at 1%.”
From underground and above-ground water to metals, minerals, and petrochemicals, Mr. Grantham says that “we are running out of everything.” And “if China were to become as rich as the U.S. we’d need 13 planets.”
According to Mr. Grantham, the world will need to learn to live with less, and it’ll have to do it “now, not in 100 years.” He says that “we are entering the age of frugality,” and that the “investment implications are huge.”
Mr. Grantham believes that learning to live with less will be “the central investment issue of the next 50, 100, 200 years.”
For the Obama administration, Mr. Grantham sees the opportunity to “kill to two birds with one stone” – bird one being the economic crisis and bird two, the environmental one. “My advice,” he said, is to target “direct spending at energy self-sufficiency.”
About the Lynford Lecture Series
Each year, the Lynford Lecture features a prominent thinker who explains complex information and important ideas with clarity and concision. NYU-Poly Trustee Jeffrey H. Lynford, a Philanthropist, Chairman, Reis Inc, and his wife, Tondra Lynford, and NYU-Poly’s Institute for Mathematics and Advanced Supercomputing (IMAS) make the series possible. The Lynfords were instrumental in bringing IMAS co-directors Drs. David and Gregory Chudnovsky to NYU-Poly. Past Lynford Lecture speakers include Gerald M. Rubin, genome sequence pioneer, and Alan Kay, pioneer of the modern personal computer.