Ben "Nostradamus" Graham

The markets and the economy are cyclical beasts. We all know that. But from time to time we all (or almost all) forget about it. That's part of the cycle too.

Nothing new so far, right?

What amazes me the most, though, is how predictable these cycles are. No, not the timing of them. Just how they happen and that they will happen. The same mechanisms, over and over again.

Just to illustrate one, consider this short passage from Security Analysis, by the legendary Ben Graham, from 1934. Regarding real estate assets:

During the great and disastrous development of the real estate mortgage-bond business between 1923 and 1929, the only datum customarily presented to support the usual bond offering -- aside from an estimate of future earnings -- was a statement of the appraised value of the property, which most invariably amounted to some 662/3% in excess of the mortgage issue. If these appraisals had corresponded to the market values which experienced buyers of or lenders on real estate would place upon the properties, they would have been of real utility in the selection of sound real estate bonds. But unfortunately they were purely artificial valuations, to which the appraisers were willing to attach their names for a fee, and whose only function was to deceive the investor as to the protection which he was receiving.

The method followed by these appraisals was the capitalization on a liberal basis of the rental expected to be returned by the property. By this means, a typical building which cost $1,000,000, including liberal financing charges, would immediately be given an "appraised value" of $1,500,000. Hence a bond issue could be floated for almost the entire cost of the venture so that the builders or promoters retained the equity (i.e., the ownership) of the building, without a cent's investment, and in many cases with a goodly cash profit to boot.
(Security Analysis, Second Edition, 1940, Ben Graham and David Dodd, pages 139-140. All emphasis are theirs).

Recap: inflated, self-serving appraisals. Check. Zero money down investment. Check. Greater fool's theory. Check. Did he allude to bonds having high credit ratings due to inflated asset prices ("deceive the investor ... of the protection he was getting")? Check again.

Sounds familiar?

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