George Soros: We Are Just Entering "Act 2" Of The Crisis
This is a very good talk given by Soros, and the transcript is provided in the link below. I have excerpted a few passages with some comments. Please read the whole thing, it really is worth your time. (Thanks for finding Tasty!)
George Soros: We Are Just Entering "Act 2" Of The Crisis, And We're Totally Screwed
Henry Blodget | Jun. 13, 2010, 9:41 PM
George Soros recently gave a speech at a conference in Vienna. Here's a transcript, courtesy of Australia's The Age. We've highlighted the important bits.
In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 — global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counterparties.
As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short term the exact opposite of what was needed in the long term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.
This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.
The first phase of the maneuver has been successfully accomplished — a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.
Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.
[My comment: This is what many of us have been saying. I understand there are doubters to this statement, and people who call us Chicken Little for making such pronouncements, but I believe these concerns are well-founded]
It is important to realize that the crisis in which we find ourselves is not just a market failure but also a regulatory failure, and even more importantly, a failure of the prevailing dogma about financial markets. I have in mind the Efficient Market Hypothesis and Rational Expectation Theory. These economic theories guided, or more exactly misguided, both the regulators and the financial engineers who designed the derivatives and other synthetic financial instruments and quantitative risk management systems which have played such an important part in the collapse. To gain a proper understanding of the current situation and how we got to where we are, we need to go back to basics and re-examine the foundation of economic theory.
[My comment: This is a very important and relevant paragraph. EMH is demonstrably false, because it presumes that the market is always progressing or regressing back to some stable mean. The point about modern economic theory assuming stability is that it is a *flawed assumption*. I think engineers would make better economists than economists. Of Modeling, Risk, Financial Innovation, and Liquidity Crises - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=344745. We need to understand economics and finance from the ground up, why it breaks, and why this is a *feature of the current system*, not just some infrequent and random by product: Maturity transformation considered harmful: an unauthorized biography of the bank crisis - http://unqualified-reservations.blogspot.com/2008/09/maturity-transformation-considered.html. And while this is the base problem, it is amplified by financial and monetary policy, such that risks become truly systemic]
..... Large portion of the article (please read, it is very good) ......
It is clear that the reforms currently under consideration do not fully satisfy the five points I have made, but I want to emphasize that these five points apply only in the long run. As Mervyn King explained, the authorities had to do in the short run the exact opposite of what was required in the long run. And as I said earlier, the financial crisis is far from over. We have just ended Act II. The euro has taken center stage, and Germany has become the lead actor. The European authorities face a daunting task: they must help the countries that have fallen far behind the Maastricht criteria to regain their equilibrium while they must also correct the deficiencies of the Maastricht Treaty which have allowed the imbalances to develop. The euro is in what I call a far-from-equilibrium situation.