The Macleans.ca Interview: George Soros
The legendary financier on the U.S. housing crisis, the overall state of the economy, and reluctantly becoming a "prophet of doom"
Philippe Gohier | Jun 13, 2008
As a speculator, George Soros is perhaps most famous for bringing the Bank of England to the brink of collapse in 1997, raking in over $1 billion in a single day. As a philanthropist, he's indelibly associated with any number of political causes. But in his new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means, Soros confesses he's always "desperately wanted" to be taken seriously, not as an investment guru or as a political agitator, but as a philosopher. Soros recently spoke with Macleans.ca.
Q: You’ve come to some grim conclusions about the market in the book. For example, you write that the bottom of the housing market is still “further than people think.”
A: Behind the housing bubble, there’s a super bubble which has been growing for the last 25 years. Every bubble has an element of reality and an element of fantasy, of misinterpretation. The reality has been a trend of ever-increasing use of credit, of credit expansion. The misconception is that markets tend toward equilibrium and can be left to their own devices, to take care of their excesses. In the boom phase, it’s very pleasant because you enjoy credit creation and, with that, comes wealth creation. In the bust phase, it’s very unpleasant because you have credit contraction, a reduction of leverage, a decline in the value of collateral, etc. and that involves wealth destruction. I’m afraid that I am a prophet of doom. I don’t like it and I don’t think I’m predicting anything unconditional because I think that how the situation will evolve depends on how the authorities respond to it. But, unfortunately, we are in that phase of the super bubble.
Q: You raise an interesting paradox in the book's introduction: When interest rates were really low, banks were eager to lend people money. But at the same time, they were repeatedly repackaging those loans to avoid the risks that come with lending people money.
A: They thought they were reducing the risk by packaging it and slicing it. In actual fact, by transferring it from people who were familiar with the risks to people who were not familiar with them, they were actually increasing the risks.
A: Well, I think a lot of it was self-deception. There was a certain amount of deliberate exploitation, but most of it was self-deception, a false interpretation of reality, a misconception. But it’s a convenient misconception, because leaving markets to take care of their own excesses is very convenient for people in control of the financial institutions.
A: The main misconception was what I call market fundamentalism, [the idea] that markets are perfect. Or, at least, that they are better than regulators and therefore we should leave it to markets and we should deregulate.
Q: You argue that freedom of thought doesn’t mitigate the misconception problem—that is, that an open society can’t produce a perfect market. Does it actually do the opposite?
A: It’s a somewhat different issue. I discovered a misconception in my own ideal of open society, which I kind of took over from Karl Popper. We all took it for granted that the purpose of critical thinking is to improve our understanding of reality. That’s the cognitive function. Then there’s this manipulative function, which is to change reality to meet your own desires, to influence people in a way that they’ll follow you. Politics is dominated by the manipulative function. You can’t take it for granted that critical thinking will give you a better understanding of reality. What you took for granted, you have to introduce as a requirement. I’m not abandoning open society at all; I’m just taking another step in what is necessary to bring about a well-functioning open society.
America, because of the adversarial, competitive nature of the political and economic system has really lost sight of the importance of understanding reality. The proof of it is Karl Rove and the Bush machine, which was fabulously successful in manipulating people, spinning the events, as manifested by the fact that Bush got 90 per cent popularity when he declared war on terror and could take the country to invade Iraq under false pretenses. It achieved the exact opposite of what he hoped to achieve. He wanted to demonstrate American supremacy and America’s influence in the world has suffered a terrible blow. He thought that he would make his brand politically dominant and his name is dirt. It shows how important it is to recognize reality and not distort it.
Q: According to your book, “We are in the midst of a financial crisis the likes of which we haven’t seen since the Great Depression” and that “the entire financial system is on the brink of a breakdown.” Can you give me an idea of what that’s going to feel like?
A: I actually think the acute phase is behind us. We had a pretty serious breakdown. The very core of the system was malfunctioning, and it’s still sputtering pretty badly. But the full effect of the damage is yet to be felt, both for the financial institutions and for the real economy.As far as the financial institutions are concerned, they’ve recognized a lot of losses. But they perhaps haven’t fully recognized all the losses they may incur from holding mortgages if the decline in housing prices hasn’t run its course, which I believe is the case. We are probably halfway in the decline and that decline is going to be quite steep—steeper than currently anticipated because housing prices are going to overshoot on the downside as they overshot on the upside. How far they overshoot depends on how the authorities react to the problem, because what causes the overshoot is foreclosures. It unbalances the supply. In my estimation, there could be something like two million foreclosures in the foreseeable future, half of it from subprime sector and half of it from option adjustable rate mortgages. So you need to take steps to try to reduce the number of defaults and the number of foreclosures. It’s possible to do something about it.
Q: There’s very little discussion about widespread reform of the credit sector. Instead, the authorities seem more inclined to argue about whether or not there’s a recession looming. Is the recession argument a red herring? Is it diverting attention from a more fundamental crisis?
A: No, it’s not a red herring. For the moment, the economy is actually showing considerable resilience and people think the worst is over. I’m afraid that that is not the case; we are heading for a recession, but we are not there yet.
Q: Credit expansion seems to have been an outgrowth of the American dream: it was supposed to mean everyone would be able to afford a big house, a gas-guzzling car, a luxurious vacation. Does the end of credit expansion mean the end of the American dream?
A: Well, hopefully not. I think America has been a country of great opportunity and a great ability to learn. I’m very hopeful that Barack Obama will be able to provide that leadership.
A: It was a side effect of allowing markets a free-hand. I suppose I should say it was a side effect of market fundamentalism.
Q: What I mean is whether credit expansion was intended as a mechanism to offset the disparity in income?
A: The idea was that subprime mortgages, etc. would increase house ownership and so on. It’s the people who bought into it who are the worst affected by the bubble. Prince George’s County in Maryland—it’s sort of the yuppie black community—is the worst affected. They bought into the ownership idea and the first object was a house. They don’t have other assets, so they don’t have anything to fall back on.
Q: How can Obama guide the U.S. through the crisis?
A: No, no, I don’t think so. I mean, it is in a way, because market fundamentalism is associated with the Republican party. It has deeper roots than Bush. The super bubble was really launched by Reagan.
Q: That’s an interesting point about how the super bubble is about 25 years old. A little over a quarter of the U.S. population is under 20, meaning they’ve never known anything else than the super bubble as an economic system. What does the future hold for them?
A: Well, I think it’s still the land of opportunity. I wouldn’t mind being a young man today.
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