- Hardcover: 208 pages
- Publisher: PublicAffairs (May 5, 2008)
- Language: English
- ISBN-10: 1586486837
- ISBN-13: 978-1586486839
- Product Dimensions: 5.5 x 0.6 x 8.5 inches
- Shipping Weight: 10.4 ounces (View shipping rates and policies)
- Average Customer Review: 3.2 out of 5 stars See all reviews (92 customer reviews)
- Amazon Best Sellers Rank: #491,291 in Books (See Top 100 in Books)
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The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means Hardcover – May 5, 2008
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"The London Times" "They're wrong about oil, by George: In short, the standard economic assumption that supply and demand drive prices is only a starting point for understanding financial markets. In boom-bust cycles, the textbook theory is not just slightly inaccurate but totally wrong. This is the main argument made by George Soros in his fascinating book on the credit crunch, "The New Paradigm for Financial Markets," launched at an LSE lecture last night."
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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.
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.
Soros gives a brief account of economic history beginning with the repeal of the gold standard in 1972. He believes that the dominant economic philosophy of the past 30 years (conservative) has led us to the present housing crisis and he gives a recap of economic events to over this period. He offers an economic theory that contradicts the conservative dogma that markets always tend towards equilibrium. Soros claims that markets tend towards periodic bubbles for two reasons: (1) People have imperfect knowledge and (2) while institutions aptly consider the consequences of a single economic action (i.e. issuing a single sub-prime loan), they do not consider the consequences where that economic action is converted into a general policy (i.e. issuing sub-prime loans to everybody). He faults excessive deregulation of the financial industry for the present housing crisis and points out that the US taxpayer is eventually forced to bail out the system. Since market forces do not automatically protect tax payers, we have a right to be protected under a sensible set of regulations.
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