George Soros, “New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means” (MP3 audio), New America Foundation, 2008/04/07

I’ve been interested in George Soros’ idea of reflexivity.  This has theory has been revalidated in since it was first published in 1998.

According to Soros, the Superbubble is the product of a 25-year feedback loop. That loop involves market fundamentalists, who rose to power in the Reagan administration, acting on their belief that markets generally tend toward equilibrium if left alone by the government. In the process, over-deregulating markets and producing a long series of speculative bubbles.

Ironically, those fundamentalists pioneered a new cocktail of government intervention–usually some combination of monetary policy, Keynesian fiscal stimulus, targeted re-regulation, and some kind of geopolitical adjustment, to stabilize the markets and correct for “minor” busts like the 1987 crash, Long-Term Capital Management, the Internet bubble and now the housing bubble.

According to Soros, each succeeding bailout, instead of calling into question the wisdom of continued de-regulation, further entrenched market fundamentalists in their belief. The Fed, led for most of this period by Alan Greenspan, a market fundamentalist himself, became the trusted steward of not only banks, but of market stability more broadly. Without a regulator supervising these new markets and assuring investors that some minimum standards necessary for stability were being met, markets began to securitize risk at a dramatic rate in the mid-1990s. With Greenspan at the Fed, market institutions knew they were playing with an implicit government safety net and it led to signficant excesses. Nevertheless, until a few months ago, many believed that they had tamed the beast of risk in a voluntary, market-based way.

The subprime bubble was part of this hedging of risk. With loads of offshore dollars looking to invest in the rock-solid American housing market, institutions turned to collateralized debt obligations as a means to mitigate the risk incurred by expanding the mortgage market to home buyers with below-standard credit ratings. With no regulation, however, CDOs became untethered from the actual risk in the U.S. housing market, making it impossible to accurately value the securities once the underlying mortgages started defaulting at unexpected rates. Without a way to value the security, institutions are now in the process of simply having to write off billions of dollars of securities, creating a solvency question that is freezing up corporate lending, and impacting the real economy.

George Soros’s New Paradigm: Behind and Beyond the Superbubble | New America Blogs

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One comment on “George Soros, “New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means” (MP3 audio), New America Foundation, 2008/04/07
  1. Bob Calder says:

    That much was obvious.

    My observation is that everybody involved overestimated capacity.

    In the case of Banks, it was expected because they are just plain stupid.

    But in the case of AIG, it was unforgivable. Either it was insurance or it was not. If it was not, it wasn’t their business to do (ie. create the instruments.) But if it was (insurance/risk,) then there was finite capacity because that’s what insurance is/does.

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