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Jeremy Grantham on the economy

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February 09, 2008 – Comments (1)

Finanical Armageddon has posted an interview with Jeremy Grantham, who calls this financial crisis the worst we've had in the post-war era.

Parts that caught my attention: 

"I have an exhibit that shows the 30 years prior to 1982 when the debt-to-gross domestic product ratio was completely flat at 1.2 times. Total debt is defined as government debt, personal debt, corporate debt and financial debt. Then in the 25 years after 1982, the flat line goes up at a 45 degrees angle from 1.2 times to 3.1 times GDP. Massive. In the first 30 years, when debt is flat, annual GDP growth is its usual battleship, growing at 3.5% and hardly twitching. After the massive increase in debt, GDP, far from accelerating, grew at 3%. So debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology. It is not driven by what I owe you and you owe me."

I had to read the next one several times to sort it out.

"I have yet to meet a private-equity firm that put into its spreadsheet the assumption that system-wide profit margins could decline by 20% to 30%. They have taken the current, abnormally high profit margins as a given and then determined to improve them by, let's say, 15% and assume everything works out pretty well.

But if the base declines by 20%, even if they end up improving margins by 15%, they are going backwards. And if they pay the 25% premium up front, which was normal, and if they leverage 4-to-1, which was normal, then they almost precisely wipe out all of the clients' money, all of the 20% in equity and if, perish the thought, they don't add 15%, but add perhaps zero to 5%, then they do more than wipe out the equity, they leave the underlying debt in ragged disarray. That is the next shoe to drop on the credit side."

1 Comments – Post Your Own

#1) On February 11, 2008 at 9:07 PM, TMFKopp (98.50) wrote:

I have yet to meet a private-equity firm

Funny... I used to work for a PE firm so I have a bit of a view on this (at least to the firm I worked at). We were actually very careful about margins and rarely baked in margin expansion when modeling. 

Of course, I was at a firm that was primarily investing equity, not making huge LBOs.  

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