A Conversation with George Soros at MIT

November 26, 2008 | Sovestor

George Soros shares his view on global economic crisis and bubble & bust. This exclusive MIT event happened very recently. Discussion revolves around his views and ideas as reflected in his latest book: The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means. In addition, Mr. Soros also shares his background and his concept of reflexivity in analyzing the global market.

Key points of the conversation:

The idea that you can predict the future is non-sense.
You can not base decision only on knowledge or rational expectation due to your imperfect understanding of the world and the markets.
Cognitive function and participating function affect realty; these two functions interfere each other and therefore outcome is never clear.
Seemingly great ideas that work well in the beginning at the end will not work well anymore.
It is better to assume that market is always wrong due to distorted bias way of the market participants.
The prevailing movement of the market can affect the fundamental of the market and vice versa.
Initially reality conforms the trend & misconceptions. Then the self-reinforcing process starts as long as it becomes unsustainable (super-bubble) and shows errors of market fundamentalism; then you'll get reversal which is a non-linear event.
There are two components of how a super-bubble starts: Trend that occurs in reality (e.g.: increasing use of leverage, discover of internet and technological innovation). Misinterpretation of the reality (e.g.: internet would change everything which caused internet super-bubble in 2000, real estate would continue to go up forever which causes housing super-bubble in 2006-2007)
Financial engineering is based on false premise/concept that market always moves to equilibirum and incorrect assumption that market can self-regulate. You can not leave it all to the market. There are moral and political issues.
Allowing Lehman Brothers to collapse was a mistake that changed history. Policy makers did not anticipate that the default of Lehman Brothers would cause increase of systemic risk in the markets.
The idea that you can reduce risk by geographic diversification in the securitization of real-estate mortgage loans is incorrect assumption which caused the value of the mortgage exceeds the value of the house which is happening now. You have to downside the mortgages to 80% of the current value of the homes in order for the housing market to stabilize. This can be done but it is going to be very difficult.
The system meltdown that is happening now is unpredictable. Severity of the crisis require necessary steps by the government. There are three issues that need to be resolved: 1. Restart lending and encourage the banks to lend again by injecting equity in the form of convertible bonds (recapitalize the banks) with reasonable rate (not to impair the banks' ability to operate) rather than taking off the bad loan. Treasury would act as underwriter. There is no need to nationalize a bank. 2. Prevent housing overshooting on the downside the way it overshot on the upside by reducing foreclosure to minimum to restrict the supply (mortgage reorganization). 3. Stabilize global economy and enable emerging countries that are financially sound to run fiscal deficit to help avoiding global depression.
Hedge funds will be reduced in size between half to two-third due to huge losses, deleveraging, and lack of liquidity.
The current economic crisis is the worst economic crisis since 1930. The current crisis is similar to 1930 crisis but it is going to unfold differently. In order to deal with asset bubble you can not deal it simply with monetary tools alone (e.g.: increasing interest rate) as markets do have moods. You need to manage credit expansion and contraction (e.g.: through lower margin requirement policy)
Autocratic regime in many oil-rich countries who are opposed to the US and also what Soros calls 'Open Societry' is a phenomena that has been financed by global commmodity boom. This regime will be decimated as the global commodity price declines which is happening now.
Ever since financial market existed, you have financial crisis. History of central banking is always characterized by introducing reforms and regulations due to crisis.
The ideology that says markets are perfect is wrong. However, regulations are also wrong and infact more imperfect than the markets because regulators are not only human but also bureaucratic and subject to political influence. So whenever possible you want to use market mechanism. However you must regulate credit as well as money. Regulating credit also means the financial sector will not be as profitable as in the past because before the past profitability was possible due to usage of excessive leverage when times were good.
As citizen, one should be concerned with making the existing rules better even if his/her action is contradictory in order to critisize existing rules that do not work (e.g.: Soros shorted British poundsterling because he realized the European currency system and rules had big flaws at that time and through his Poundsterling shorting position, revealed the flaws).
Uncertainty (not just risk and profit) which by its nature uncomputable and unpredictable needs to be incorporated into the reflexivity model. There are similarities of reflexivity model with formation of cities. Mr. Soros hopes reflevitiy theory will be incorporated in the teaching of the economic.
Injecting money to the banking system by taking off toxic loans is the wrong way to solve this crisis. Unfortunately, in some cases, the appropriate alternative for corporations that can not get credit due to excessive leverage and bad business model might be to bail them out or else, US would face further rapid increase in unemployment.