« "Food Prices: The Need for Insurance" | Main | Paul Krugman: Self-Inflicted Confusion »

Friday, April 25, 2008

"The Financial Crisis: An Interview with George Soros"

A few passages from a much longer interview:

The Financial Crisis: An Interview with George Soros, NYRB: The following is an edited and expanded version of an interview with George Soros ... by Judy Woodruff...

Judy Woodruff: You write in your new book, The New Paradigm for Financial Markets,[1] that "we are in the midst of a financial crisis the likes of which we haven't seen since the Great Depression." Was this crisis avoidable?

George Soros: I think it was, but it would have required recognition that the system, as it currently operates, is built on false premises. Unfortunately, we have an idea of market fundamentalism, which is now the dominant ideology, holding that markets are self-correcting; and this is false because it's generally the intervention of the authorities that saves the markets when they get into trouble.

Since 1980, we have had about five or six crises... Each time, it's the authorities that bail out the market, or organize companies to do so. ... But somehow this idea that markets tend to equilibrium and that deviations are random has gained acceptance and all of these fancy instruments for investment have been built on them. ... The large potential risks of such investments are not being acknowledged.

Woodruff: How can so many smart people not realize this?

Soros: In my new book I put forward a general theory of reflexivity, emphasizing how important misconceptions are in shaping history. So it's not really unusual; it's just that we don't recognize the misconceptions.

Woodruff: ...You said it would have been avoidable if people had understood what's wrong with the current system. Who should have recognized that?

Soros: The authorities, the regulators—the Federal Reserve and the Treasury—really failed to see what was happening. ...

Woodruff: The chairman of the Fed, Mr. Bernanke? His predecessor, Mr. Greenspan?

Soros: All of the above. But I don't hold them personally responsible because you have a whole establishment involved. The economics profession has developed theories of "random walks" and "rational expectations" that are supposed to account for market movements. That's what you learn in college. Now, when you come into the market, you tend to forget it because you realize that that's not how the markets work. But nevertheless, it's in some way the basis of your thinking.

Woodruff: How much worse do you anticipate things will get?

Soros: Well, you see, as my theory argues, ... it very much depends on how the authorities are going to respond... But the situation is definitely much worse than is currently recognized. ...

Woodruff: So how long will this last?

Soros: Well, it depends on when the authorities wake up, because you need to reduce the number of foreclosures. ... You need to arrest the decline in house prices, but you also need to prevent human suffering and social disruption because it's going to be very, very severe. ...

Woodruff: You said the Federal Reserve had to step in to engineer the buyout by J.P. Morgan of Bear Stearns to prevent a much bigger catastrophe. ... Is this an unhealthy amount of risk that the Fed has taken on?

Soros: This is their job, whether unhealthy or not; I don't think it's actually so severe. But that is their job, to save the system when it is in danger. However, because that is their job, it ought to be their job also to prevent asset bubbles from developing. And that task has not been recognized. ...

Woodruff: What of your book and the philosophy that comes of it?

Soros: In human affairs, as distinguished from natural science, I argue that our understanding is imperfect. And our imperfect understanding introduces an element of uncertainty that's not there in natural phenomena. So therefore you can't predict human affairs in the same way as you can natural phenomena. And we have to come to terms with the implication of our own misunderstandings, that it's very hard to make decisions when you know you may be wrong. You have to learn to recognize that we in fact may be wrong. And, even worse than that, it's almost inevitable that all of our constructs will have some kind of a flaw in them. So when it comes to currencies, no currency system is perfect.

So you have to recognize that all of our constructions are imperfect. We have to improve them. But just because something is imperfect, the opposite is not perfect. So because of the failures of socialism, communism, we have come to believe in market fundamentalism, that markets are perfect; everything will be taken care of by markets. And markets are not perfect. And this time we have to recognize that, because we are facing a very serious economic disruption.

Now, we should not go back to a very highly regulated economy because the regulators are imperfect. They're only human and what is worse, they are bureaucratic. So you have to find the right kind of balance between allowing the markets to do their work, while recognizing that they are imperfect. You need authorities that keep the market under scrutiny and some degree of control. That's the message that I'm trying to get across.

    Posted by on Friday, April 25, 2008 at 12:36 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (24)

    TrackBack

    TrackBack URL for this entry:
    http://www.typepad.com/services/trackback/6a00d83451b33869e200e55210fb0a8834

    Listed below are links to weblogs that reference "The Financial Crisis: An Interview with George Soros":


    Comments

    Feed You can follow this conversation by subscribing to the comment feed for this post.

    -->