I listened to George Soros's conference call this morning organized by Steve Clemons of the Washington Note. Soros presented arguments from his brand new book The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.
His argument was that the global financial system is built upon a false paradigm. All human constructs are flawed. We need to stop relying solely on the market. He said financial markets do not tend toward equilibrium. Rather they move dramatically, swinging in extremes of despair and optimism. Therefore financial bubbles emerge.
Bubbles are partly based on realities, such as the Internet. But some parts are misconception. The extremes are occurring more frequently than they are supposed to. Now you have two bubbles: the housing bubble, which has burst, and a super bubble that has been developing for the past 25 years since the Reagan-Thatcher years. It involves an increased use of credit relative to GDP. Market fundamentalism is a misconception that has followed and led to financial crisis. The authorities have tried to intervene, stimulating the economy, but also reinforcing the misconception that markets can be left to their own devices.
What we have now is a turning point in which this interaction doesn't work anymore.
What about other busts that might hit the global economy? He said, the scariest market is the credit default swaps (CDS). (Related Bloomberg article here.) It is totally unregulated and hangs like a Sword of Damocles. A clearinghouse is needed in which trades would be registered under established rules. Otherwise, there is too much uncertainty about counterparties. From Bloomberg:
Credit default swaps -- a way to bet on the creditworthiness of a company -- may be the next crisis area because the market is unregulated, and it's impossible to know whether counterparties can meet their obligations in the event of a bond default. The market has a notional value of about $45 trillion -- or about half the total wealthof U.S. households. Soros recommends the creation of an exchange with a sound capital structure and strict margin requirements, where current and future contracts could be traded.
Soros said the acute phase of the crisis is over. He said the bailout of Bear Stearns proves that the authorities will do what they need to do. The Bear Stearns bailout was a market bottom. But now you have fallout, which cannot pass without having long term effects on the global economy—it’s whistling in the wind.
Soros believes that authorities do need some control over asset bubbles. They cannot go by simple rules but it is more of an art to make sure excesses don’t go too far. You need margin regulations.
Where is future economic growth going to come from? First, you need to minimize U.S. foreclosures. The American consumer has been the motor of the global economy, but that is coming to an end. You need a new motor. The big challenge is global warming and investments are needed to reduce carbon emissions. Addressing climate change could be the next motor for economic growth.
Economist Paul Krugman said this morning at the Carnegie Council that nonbank institutions could be nationalized in the United States. He called it the Nordic Model. I asked Mr. Soros if that would be possible. He said it is a fall back and a possibility but raising capital is preferable to nationalization.
The last question came from a Russian journalist who asked if Soros planned to invest in Russia. "Absolutely not," he said, saying he had been burned too many times in Russia. He is on the record for calling Russia "robber capitalism"--with no legal or financial controls.
Photo "Twisted Worlds" by Jeff Kubina.