George Soros : The game changer

[RedEarth]

In the past, whenever the financial system came close to a breakdown, the authorities rode to the rescue and prevented it from going over the brink. That is what I expected in 2008 but that is not what happened. On Monday September 15, Lehman Brothers, the US investment bank, was allowed to go into bankruptcy without proper preparation. It was a game-changing event with catastrophic consequences.

For a start, the price of credit default swaps, a form of insurance against companies defaulting on debt, went through the roof as investors took cover. AIG, the insurance giant, was carrying a large short position in CDS and faced imminent default. By the next day Hank Paulson, then US Treasury secretary, had to reverse himself and come to the rescue of AIG.

.......

On a deeper level, too, credit default swaps played a critical role in Lehman’s demise. My explanation is controversial and all three steps of my argument will take the reader to unfamiliar ground.

..........

What about credit default swaps? Here I take a more radical view than most people. The prevailing view is that they ought to be traded on regulated exchanges. I believe they are toxic and should be used only by prescription. They could be used to insure actual bonds but – in light of their asymmetric character – not to speculate against countries or companies.

CDS are not, however, the only synthetic financial instruments that have proved toxic. The same applies to the slicing and dicing of collateralised debt obligations and to the portfolio insurance contracts that caused the stock market crash of 1987, to mention only two that have done a lot of damage. The issuance of stock is closely regulated by authorities such as the Securities and Exchange Commission; why not the issuance of derivatives and other synthetic instruments? The role of reflexivity and the asymmetries identified earlier ought to prompt a rejection of the efficient market hypothesis and a thorough reconsideration of the regulatory regime.

Now that the bankruptcy of Lehman has had the same shock effect on the behaviour of consumers and businesses as the bank failures of the 1930s, the problems facing the administration of President Barack Obama are even greater than those that confronted Franklin D. Roosevelt. Total credit outstanding was 160 per cent of gross domestic product in 1929 and rose to 260 per cent in 1932; we entered the crash of 2008 at 365 per cent and the ratio is bound to rise to 500 per cent. This is without taking into account the pervasive use of derivatives, which was absent in the 1930s but immensely complicates the current situation. On the positive side, we have the experience of the 1930s and the prescriptions of John Maynard Keynes to draw on.

The bursting of bubbles causes credit contraction, the forced liquidation of assets, deflation and wealth destruction that may reach catastrophic proportions. In a deflationary environment, the weight of accumulated debt can sink the banking system and push the economy into depression. That is what needs to be prevented at all costs.

http://www.ft.com/cms/s/0/49b1654a-ed60-11dd-bd60-0000779fd2ac.html?nclick_check=1

[acmavm]

1. EEK! Now this article is REALLY depressing. And Soros knows what he's

talking about. The way people are talking this week, it sounds like it's gonna take YEARS before we see (if we do) any evidence of an economic recovery. Is the whole country (except for Wall Street of course) supposed to just fucking go under like lambs? This is mind boggling.

<snip>
Now that the bankruptcy of Lehman has had the same shock effect on the behaviour of consumers and businesses as the bank failures of the 1930s, the problems facing the administration of President Barack Obama are even greater than those that confronted Franklin D. Roosevelt. Total credit outstanding was 160 per cent of gross domestic product in 1929 and rose to 260 per cent in 1932; we entered the crash of 2008 at 365 per cent and the ratio is bound to rise to 500 per cent. This is without taking into account the pervasive use of derivatives, which was absent in the 1930s but immensely complicates the current situation. On the positive side, we have the experience of the 1930s and the prescriptions of John Maynard Keynes to draw on.

-AUGH!!!! MORE-

[wolfgangmo]

2. Speaking truth to power.

The man is right. It is going to get really bad before it gets better. I only hope we can hold out.

As for me, they can have my house when they shoot my ass.

[D-Lee]

3. Great article!

Soros is so right. Wish the article had been longer ...

One danger that he did not touch upon is the manipulation of interest rates for political purposes, as done throughout most of the Bush years. That encourages gambling with bonds and bond equivalents. On the consumer front, it also misleads consumers -- as those who thought it was safe to take an adjustable rate mortgage because the federal interest rate was unrealistically low and kept "steady" for political purposes.

And definitely bring back the uptick rule!

[Hestia]

4. Here's a thought

http://deepcapture.com

[DUlover2909]

7. Internet Explorer cannot display the webpage

[eridani]

5. Now whythehell is Soros not on Obama's economic team?

Needs more people on it who predicted the current bullshit.

[elleng]

6. He might not be well suited to be ON THE TEAM officially,

but he surely should be consulted and listened to. Hope summers etc aren't too arrogant to do that.

And Warren Buffet, too.