George Soros (Soros Fund Management Founder) – Interview with Alan Murray, WSJ (Nov 2013)

Chapters

Abstract

Navigating the Uncertain Future: Understanding the Financial Crisis and the Path Forward

In this article, we delve into a comprehensive retrospective analysis of the financial crisis, examining the causes, the aftermath, and the lessons learned. The primary focus is on the insights of renowned investor George Soros, who not only predicted the crisis but also offers a path forward in navigating the uncertain economic landscape.

The Genesis of the “Super Bubble” and Its Burst

The financial crisis, a pivotal moment in modern economic history, was characterized by the bursting of a “super bubble” that had been growing for over 25 years. Contrary to Soros’ early predictions, which anticipated an earlier occurrence, the crisis materialized significantly later, around 2008. This “super bubble” was fueled by a widespread misconception that markets are inherently self-correcting, a belief bolstered by the consistent intervention of authorities to bail out failing institutions and stimulate the economy.

The bankruptcy of Lehman Brothers in 2008 marked a watershed moment, signifying the total breakdown of the financial system. This event triggered massive support from the Federal Reserve and governments worldwide, effectively placing the global financial system on “artificial life support.”

Aftermath: A Landscape of Economic Uncertainty

Post-crisis, there’s a looming danger of complacency, with the potential risk of reverting to “business as usual” practices. This approach could inadvertently reinflate the bubble. The market currently oscillates between fears of inflation and deflation, creating a possibility of stagflation or a prolonged period of slow growth, high inflation, and high-interest rates. Soros emphasizes the importance of adapting investment strategies to this uncertainty.

Rethinking Market Fundamentalism and Regulation

Central to Soros’ analysis is the critique of market fundamentalism – the belief in the self-regulating nature of markets. He argues that bubbles are an inherent part of market behavior and that a robust regulatory system is essential to prevent their excessive growth. The role of regulators, therefore, becomes crucial in counteracting market biases and controlling not just the money supply but also credit conditions to mitigate risk.

Soros advocates for an expansion of authority for bodies like the Federal Reserve, to implement policies like varying margin requirements and control over banking practices, drawing inspiration from regulatory approaches in countries like China. However, he also acknowledges the positive aspects of financial bubbles, such as spurring technological and financial innovation, while cautioning against unchecked innovation in flawed markets.

Government’s Role in the Economy: Balancing Regulation with Market Efficiency

Soros clarifies his stance on government involvement in the economy: while he champions strong regulation, he also recognizes the efficiency of markets in resource allocation. The challenge lies in distinguishing between regulations grounded in prudence and those influenced by political considerations. Key to this approach is empowering bodies like the Federal Reserve and the SEC with adequate controls over financial instruments.

Perspectives on Policy Approaches: From Bernanke to Global Implications

Chairman Bernanke’s role in the crisis is acknowledged, particularly his initial underestimation of the subprime problem and subsequent adaptation to the crisis. Soros notes Bernanke’s reluctance to actively prick bubbles, a stance shared by his predecessor, Alan Greenspan.

Globally, countries like China emerged differently from the crisis, benefiting from globalization and positioned to gain from the collapse of the international financial system, in contrast to developed countries for whom the crisis was systemic.

The Persistence of Market Fundamentalism and Its Implications

Despite the crisis and its revelations, market fundamentalism continues to influence economic thinking. This persistence is partly due to the financial sector’s vested interest in maintaining a status quo that has historically generated high profits. Some regulators recognize the system’s flaws, but there is resistance to change, especially from practitioners benefiting from the existing structure.

Embracing Instability and Enhanced Regulation

The acknowledgment that markets do not inherently tend toward equilibrium could lead to increased market instability. However, this realization could also result in an enhanced role for regulators like the Federal Reserve, marking a significant shift in how we approach economic policy and regulation in the wake of one of the most tumultuous periods in financial history.

Supplemental Information

Soros predicted the financial crisis 10 years in advance due to excessive credit and leverage, coupled with the misconception that markets are self-correcting. Authorities’ interventions to save failing institutions and provide stimulus reinforced the use of credit and the belief in market self-correction, inflating the bubble.

The bankruptcy of Lehman Brothers in 2008 marked a turning point, leading to a total breakdown of the financial system. The Federal Reserve and government intervened with artificial life support measures, such as expanding the balance sheet and issuing guarantees.

There is a danger of reinflating the bubble through excessive use of leverage and monetary expansion. The fear of inflation could drive up interest rates, choking off recovery and leading to stagflation, a combination of slow growth and high inflation.

Soros advocates for a balanced and nuanced investment approach, recognizing the possibility of runaway inflation or deflation. He exited the market in early 2009 after a successful year, preserving his capital and securing a decent return.

Soros argues against market fundamentalism, emphasizing the inherent bubble-prone nature of markets. He proposes regulatory interventions to counteract excessive market biases, recognizing that regulators will make mistakes but should interfere as little as possible. Regulators should control credit conditions, minimum capital requirements, and margin requirements to keep market exuberance in check.

Soros acknowledges the risk of overregulation and the negative impact of political influence on regulations. He argues for the need for regulations based on prudential grounds, separate from political considerations. The Federal Reserve and the SEC should have the primary responsibility for regulation, with a focus on maintaining a distance between regulators and the political process.

Initially underestimating the subprime problem, Bernanke quickly recognized the contagion and learned rapidly. China emerged as the major beneficiary of globalization and the subsequent financial collapse. This external shock benefited China, while the flawed international financial system affected developed countries.

Notes by: Random Access