The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means

The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means | George Soros | Insightful for the layman but not so much for those with backgrounds in economics

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The New Paradigm f...

	The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means George Soros PublicAffairs, 2008 - 208 pages average customer review:based on 64 reviews view larger image
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Buy it.

This book will take you a long way in understanding what just happened in the financial markets and with the housing bust.

Whether or not you want to buy Soro's theory of 'reflexivity' as 'the new paradigm' is up to you, but he does make the simple and accurate point that any economic theory that had human beings objectively describing the world and then making decisions based on that 'accurate' intelligence is a silly theory.

Market fundamentals? Those are actually our perception of market fundamentals, so if we delude ourselves about those fundamentals(housing prices will never come down, the dow is going to 30,000) then we mis-take the markets. And people can be delusional as all hell if you haven't noticed. It just keeps on happening...

Soros describes bubbling phenomena with his 'far-from-equilibrium' theory. He gives an 8-stage descriptive theory of bubbles (pg. 65-66) that is, in and of itself, enough reason to buy this book. Look at gold in the 1970s...it followed the exact pattern.

This text advanced my understanding of how markets work and why it is that human idiocy is such an important variable. George wants to explain how this idiocy can actually drive a market, and I appreciate the attempt.

Soros also lets his political opinions be known, but so what. You don't have to agree with him.

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Insightful for the layman but not so much for those with backgrounds in economics

Soros' book offers quite a few insights into the financial markets for the layman but not so many for those with backgrounds in economics and financial markets (academic or practical). In short, the book's most important insights are (not necessarily in order of importance):

1) Soros' views on what he calls "reflexivity". He posits that the current prevailing paradigms in economics that stress that supply and demand are independent of the actions of market participants is flawed AND that, contrary to rational expectations theory, markets may not reflect economic fundamentals (i.e., may instead reflect "herd mentality"). Soros' view is not new with respect to what he has written in past. For more detailed discussion on "reflexivity" one should refer to his "Alchemy of Finance". With respect to behavior economics one would learn much more reading one of Schiller's books (i.e., Irrational Exhuberance or Market Volatility). They discuss the gap between actions based on economic fundamentals and psychological factors in much greater depth. However, the fact that he even provides such a critique is mind opening even to those who have had many years of education in undergraduate economics. It forces one to question the all important assumption of "rational expectations" and the assumption that in economic markets the actions of the economic actors and the results in markets are independent of each other. These assumptions undermine modern micro, macroeconomic and financial market theory and seriously need to be examined.

2) Soros provides his views as to the causes of the current financial bubble (i.e., a combination of high leverage, cheap credit, introduction of many financial instruments that have not been that well understood and corporate malfeasance). If you are student of economic history this is nothing new.

3) Soros also provides his advice as to how to mitigate (at least partially) the problems caused by the latest bubble, in particular liquidity in the housing bubble. He stated in the book (written in early 2008) that the Federal Govt. would almost inevitably have to step in to provide liguidity in the housing, banking and other financial sectors (i.e., large investment banks or what may also be called "market makers"). The weekend of September 7, 2008, he was proven correct regarding with respect to the Government's bailout of Fannie and Sallie Mae. Earlier the government had to prop up some of the larger investment bankers. He argued that not doing so would lead to massive contraction in liquidity surrounding the markets, particularly housing markets, with implications much like those leading to the Great Depression.

4) Related to item 3 above, he calls for greater regulation of financial markets due to the risks implied in high leverage, liguidity crunches, nd the inherent risks of high leverage financial instruments being introduced (especially in early stages when they are least understood - much like Collaterized Debt Obligations). With respect to CDOs, his fears were born out in mid and late 2008. It turns out that many of the participants in that market really did not have a grasp on the risks. This even included the rating agencies that were supposed to have graded these instruments (in reality they did a very poor job hence leading poor quality debt being given a higher rating and being passed on from banks and fianncial entities issuing them to other market participants).

If you have a good economics background (especially in economic history and financial instruments), items beyond 1) are not that profound. For layman, however, his views are probably of quite a bit of value.

The one weakness of the book is his lack of a much more detailed disucssion regarding poor audit work by the large accounting firms and the poor credit ratings issued by the major credit agencies. For a great discussion of the former one should read Boogle's The Battle for the Soul of Capitalism. Unfortunately few, if any, decent books for the layman have yet to come out (as of September 2008) on credit agency ratings poor performance and the resulting implications for the credit markets. Something is desperately needed here.

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Soros Gets Two Thumbs Up

I recommend Soros' "The New Paradigm for Financial Markets: The Credit Crisis of 2008." He's the back out of retirement billionaire hedge fund mogul who brought down the English pound and is blamed for the Malaysian economy's demise during the Asian economic crisis. His calling card is exploiting currency arbitrage opportunities. I recommend this book for two reasons: First, he is a smooth and elegant writer, which is nice if you appreciate the English language and a readable book. Second, he really writes on a secondary market problem, which is the real problem since it is huge due to the world of derivatives. You may need Investopedia to help translate some of what he describes, then again, you may not. As an added bonus, Soros delivers his philosophy on the markets and confirms what many already know - perception is reality and it is unpredictably dynamic. Most people understand the problem on Main Street: 6.5 million foreclosures by 2012 and $2 trillion in credit losses. Few understand the bigger problems coming from Wall Street that is closer to $40 or $50 trillion in size. The U.S. economy is $14 trillion in size. Soros helps make these matters clear. This is not reading for the faint of heart with a cup of hot chocolate in warmed hands. This is scotch and water on the rocks reading.

Peter Hebert
Author of Mortgaged and Armed
www.MortgagedAndArmed.com

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Theorists Abound

Whether we find ourselves in the aftermath or the subprime mortgage crisis, or still very much in the development of its full repercussions, there has been no shortage of industry icons trying to make sense of a catastrophic series of events that were not foreseen by an army of proprietary risk models that failed to forecast a fundamental weakness in debt markets.
Enter George Soros, the philosopher turned money manager whose special brand of socioeconomic theory stands in the face of three centuries of equilibrium theory since its birth in the pages of Adam Smith's Wealth of Nations. His theory of reflexivity propounds the idea of a two-way connection between objective and subjective aspects of reality that essentially alter each other in a reflexive manner. This abstract concept has been aptly applied to the financial markets in his 1987 text, The Alchemy of Finance, and all the more so to a general insight into the instabilities of the lending industry, specifically our most recent turn of events, in The New Paradigm for Financial Markets (2008).
While his opinions have been constantly scrutinized in academic circles for completely disregarding equilibrium theory and rational expectations, now may be the time to give reflexivity its fair due. It may not have the theoretical predictive power of traditional economic theory, but it surely makes more intuitive sense to even the most detached bystander in such "far-from-equilibrium" situations as the one in which we are currently enmeshed. There is a certain ease in being able to analyze the circumstances of an asset bubble in hindsight, be it observing the skyrocketing numbers of debt-to-GDP and specifically a housing boom as a result of negative real interest rates following the attacks on the World Trade Center, but few have been prepared to challenge the very infrastructure of the financial markets themselves.
Mr. Soros has some piercing words for the apparent efficiencies of free-market lending, especially in the context of an economy that has embraced financial services as their competitive advantage in a globalized market. The perpetrators of this crisis have, indeed, been the torchbearers of a free market ideology that has forged a religious following. Whether the time has come to add some disclaimers to an ideology peculiarly susceptible to such drastic booms and busts of the last few decades, it is up to the convincing manner in which Mr. Soros passionately states his case against its most passionate disciples. If that is not enough, he would have to resort to allowing his performance record of the last 40 years speak for itself.

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Surprise, surprise -- Republicans and free markets caused the credit crisis and Democrats will regulate us out of it

Alan Greenspan's Ayn Rand - inspired political views are responsible for the real estate bubble (the truth is that Freddie and Fannie with support from Democrats started the bubble with loans to people who could not afford them and Republicans including Greenspan tried prevent that by reforming Freddie and Fannie but were voted down by the Democrats). An "excessive reliance on the market mechanism" by Republicans and "market fundamentalists" who don't understand the Soros Paradigm -- Lack of a tendency towards equilibrium in financial markets -- (this seems to be repeated on every other page) created the "super bubble".
Actually a case can be made that government regulation gave birth to this "super bubble". Democrats like Barny Frank and Chris Dodd got the bubble going by pushing, on a massive scale, reverse redlining (giving loans to unqualified people). This Democratic over-reaction to redlining (denying loans to people who can afford them) is not discussed by the author in a forthright manner.
"Only a Democratic president can be expected to turn things around and lead the nation in a new direction. The new direction will be less reliance on the market mechanism and more reliance on more government regulation. But today as we are going through the worst financial crisis since the Great Depression more regulation of markets (including massive bail outs) is unavoidable and is being put in place by a Republican Administration as I write. If the Republicans do not get it right. Soros and Obama may well get their chance to put the market mechanism into strangle hold outlined in this book. They could destroy the power of creative destruction by wrapping it up in red tape. Economic growth could be stifled for decades.
The author's discussion of social science and natural science and supply and demand curves is done much more clearly in numerous fine textbooks. What you can't get out of textbooks or anywhere else is the back pain and spasms that Mr. Soros got at the right time. They were his early warning signs about his positions on the market. These early warning signs apparently helped him make billions. If this book does cause some readers to get a spasm it won't be the money making kind.

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