Reflexivity by George Soros
Interesting extract from an article from a Bloomberg journalist:
By James Pressley April 4 (Bloomberg) -- For 20 years, George Soros haschallenged the theory that markets, however choppy, always movetoward equilibrium. Now a meltdown has handed him rich evidence that thehypothesis isn't just flawed, it's dangerous. We are facing the worst financial crisis since the GreatDepression, Soros writes in ``The New Paradigm for FinancialMarkets,'' a book rushed online this week. The culprit, he says,is a misconception that markets can correct themselves, no matterhow we short-circuit them with easy money, massive leverage andbrain-bending synthetic instruments. ``The belief that markets tend towards equilibrium isdirectly responsible for the current turmoil,'' the billionairephilanthropist writes. ``It encouraged the regulators to abandontheir responsibility and rely on the market mechanism to correctits own excesses.'' His solutions, laid out here in uncluttered prose, range fromabandoning some financial instruments to curbing lending tocreating an exchange or clearing house for credit-default swaps.
What we are witnessing isn't your ordinary boom and bust, hesays. It's the culmination of a ``super-bubble'' that beganballooning in the 1980s, when U.S. President Ronald Reagan andU.K. Prime Minister Margaret Thatcher were in power. Borrowingswelled and financial regulations were relaxed in the belief thatthe market mechanism would keep things on an even keel. ``President Ronald Reagan called it the magic of themarketplace,'' Soros writes. ``I call it market fundamentalism.'' As the 1990s approached, the belief in efficient markets thattend toward equilibrium became entrenched in financialinstitutions, where quants armed with Ph.D.s and personalcomputers spat out ever more complex strategies and instrumentsfor coping with risk and diversification, as Peter L. Bernsteinreminded us in his recent book, ``Capital Ideas Evolving.''
`Reflexivity'
In reality, Soros says, misjudgments and misconceptionsinfluence market prices, which in turn distort the fundamentalsthat they are meant to reflect. He calls this two-way feedbackloop ``reflexivity,'' a concept influenced by the philosophy ofKarl Popper. The U.S. housing bubble is Exhibit A. Cheap money fueled morelending, which changed the value of the collateral. Other examplesinclude the conglomerate craze of the 1960s and the internationalbanking crisis of the 1980s, Soros says.
By James Pressley April 4 (Bloomberg) -- For 20 years, George Soros haschallenged the theory that markets, however choppy, always movetoward equilibrium. Now a meltdown has handed him rich evidence that thehypothesis isn't just flawed, it's dangerous. We are facing the worst financial crisis since the GreatDepression, Soros writes in ``The New Paradigm for FinancialMarkets,'' a book rushed online this week. The culprit, he says,is a misconception that markets can correct themselves, no matterhow we short-circuit them with easy money, massive leverage andbrain-bending synthetic instruments. ``The belief that markets tend towards equilibrium isdirectly responsible for the current turmoil,'' the billionairephilanthropist writes. ``It encouraged the regulators to abandontheir responsibility and rely on the market mechanism to correctits own excesses.'' His solutions, laid out here in uncluttered prose, range fromabandoning some financial instruments to curbing lending tocreating an exchange or clearing house for credit-default swaps.
What we are witnessing isn't your ordinary boom and bust, hesays. It's the culmination of a ``super-bubble'' that beganballooning in the 1980s, when U.S. President Ronald Reagan andU.K. Prime Minister Margaret Thatcher were in power. Borrowingswelled and financial regulations were relaxed in the belief thatthe market mechanism would keep things on an even keel. ``President Ronald Reagan called it the magic of themarketplace,'' Soros writes. ``I call it market fundamentalism.'' As the 1990s approached, the belief in efficient markets thattend toward equilibrium became entrenched in financialinstitutions, where quants armed with Ph.D.s and personalcomputers spat out ever more complex strategies and instrumentsfor coping with risk and diversification, as Peter L. Bernsteinreminded us in his recent book, ``Capital Ideas Evolving.''
`Reflexivity'
In reality, Soros says, misjudgments and misconceptionsinfluence market prices, which in turn distort the fundamentalsthat they are meant to reflect. He calls this two-way feedbackloop ``reflexivity,'' a concept influenced by the philosophy ofKarl Popper. The U.S. housing bubble is Exhibit A. Cheap money fueled morelending, which changed the value of the collateral. Other examplesinclude the conglomerate craze of the 1960s and the internationalbanking crisis of the 1980s, Soros says.
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