George Soros isn't Holding Back: No Quick Rebound This Time
Volume 55, Number 8 · May 15, 2008
The Financial Crisis: An Interview with George Soros
By George Soros, Judy Woodruff
The following is an edited and expanded version of an interview with George Soros, Chairman, Soros Fund Management, by Judy Woodruff on Bloomberg TV on April 4.
Judy Woodruff: You write in your new book, The New Paradigm for Financial Markets, 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: the international banking crisis in 1982, the bankruptcy of Continental Illinois in 1984, and the failure of Long-Term Capital Management in 1998, to name only three.
Each time, it's the authorities that bail out the market, or organize companies to do so. So the regulators have precedents they should be aware of. 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.
There are now, for example, complex forms of investment such as credit-default swaps that make it possible for investors to bet on the possibility that companies will default on repaying loans. Such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the US government bond market. 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: Who could have? 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. One Fed governor, Edward Gramlich, warned of a coming crisis in subprime mortgages in a speech published in 2004 and a book published in 2007, among other statements. So a number of people could see it coming. And somehow, the authorities didn't want to see it coming. So it came as a surprise.
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, you can't make any unconditional predictions because it very much depends on how the authorities are going to respond now to the situation. But the situation is definitely much worse than is currently recognized.You have had a general disruption of the financial markets, much more pervasive than any we have had so far. And on top of it, you have the housing crisis, which is likely to get a lot worse than currently anticipated because markets do overshoot. They overshot on the upside and now they are going to overshoot on the downside.
Woodruff: You say the housing crisis is going to get much worse. Do you anticipate something like the government setting up an agency or a trust corporation to buy these mortgages?
Soros: I'm sure that it will be necessary to arrest the decline because the decline, I think, will be much faster and much deeper than currently anticipated. In February, the rate of decline in housing prices was 25 percent per annum, so it's accelerating. Now, foreclosures are going to add to the supply of housing a very large number of properties because the annual rate of new houses built is about 600,000. There are about six million subprime mortgages outstanding, 40 percent of which will likely go into default in the next two years. And then you have the adjustable-rate mortgages and other flexible loans.
Problems with such adjustable-rate mortgages are going to be of about the same magnitude as with subprime mortgages. So you'll have maybe five million more defaults facing you over the next several years. Now, it takes time before a foreclosure actually is completed. So right now you have perhaps no more than 10,000 to 20,000 houses coming into the supply on the market. But that's going to build up. So the idea that somehow in the second half of this year the economy is going to improve I find totally unbelievable.
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 keep as many people as possible in their houses so that they don't come onto the market. 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. Certain communities are already hurting and it's going to get a lot worse. So action will have to be taken, but I don't think it's going to happen during this administration.