Book Review: Billionaire explores financial crisis by comparing market views, reality

When one of the world's richest men speaks, people are inclined to listen, and these days, people are listening to George Soros.

They're also reading his latest book, "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means."

Based on Soros' estimated net worth of $9 billion, Forbes magazine in October ranked the 78-year-old Hungarian-born financial speculator, investor, philosopher and activist the 99th richest person in the world.

The "new paradigm" of the book's title is Soros' theory of "reflexivity," which he credits for his financial success.

In the book, Soros delineates the global financial crisis: the bursting of the housing bubble, the credit crunch, devaluing of the dollar and implosion of such ultra-sophisticated financial instruments as hedge funds.

He offers his theory as a better way of working within and even managing financial systems.

Soros writes, "Reflexivity can be viewed as a two-way feedback loop between market participants' views and the actual state of affairs.

"People base their decisions not on the actual situation that confronts them but on their perception or interpretation of that situation. Their decisions make an impact on the situation (the manipulative function) and changes in the situation are liable to change their perceptions (the cognitive function)." He notes that in some circumstances, the two functions can work in opposite directions and interfere with each other.

To exemplify reflexivity, Soros cites the plummeting real estate market and its devastation of banks and other financial institutions, which responded by cutting back on extending credit and tightening lending standards, which further damaged the economy, dashing hopes that the credit market would stabilize on its own.

Market fundamentalism

Soros calls the idea that markets stabilize on their own and reach a state of equilibrium "market fundamentalism," which, he says, is a "false paradigm" that in the 1980s unfortunately became the guiding principle of the international financial system.

For Soros, market fundamentalism is the villain of the piece, a philosophy he equates with the laissez faire capitalism of the 19th century.

Market fundamentalism "is no better than Marxist dogma," he writes. "Both ideologies cloak themselves in scientific guise in order to make themselves more acceptable."

Tying the manipulative function in his theory to market fundamentalism, Soros refers to Alan Greenspan as "a grand master of the manipulative function."

Of Greenspan, Soros adds, "Unfortunately he put his skills at the service of the wrong cause; he was too much of a market fundamentalist."

Soros contends that the market equilibrium theory has spawned policies that would allow financial markets free rein. "Clearly an unleashed and unhinged financial industry is wreaking havoc with the economy. It needs to be reined in," he writes. "Credit creation by its nature is a reflexive process. It needs to be regulated in order to prevent excesses."

Tempering his call for regulation, Soros warns, "We must remember ... that regulators are not only human but also bureaucratic. Going overboard with regulations could severely impede economic activity."

Soros' philosophy and world view are deeply rooted in the work of philosopher Karl Popper, whose advocacy of an "open society" was fueled by the doctrine that, as Soros puts it, "freedom of thought and expression is liable to lead to a better understanding of reality."

The need for that better understanding of reality is the central thrust of Soros' book.

He writes, "However powerful we are, we cannot impose our will on the world: We need to understand the way the world works. Perfect knowledge is not within our reach, but we must try to come as close to it as we can.

"Reality is a moving target, yet we need to pursue it. In short, understanding reality ought to take precedence over manipulating it."

Soros offers no panaceas for today's financial turmoil.

"Firm predictions are out of the question," he writes. "The future depends on the policy responses the financial crisis will provoke."

According to his book, Soros also foresees a period of political and financial instability, which he hopes will be followed by the emergence of a new world order.

"The New Paradigm for Financial Markets" is an extremely sophisticated book in its detail, yet accessible enough even to the financially unsophisticated to be of value in finding a broader understanding, and perhaps even comfort and optimism, in today's economic crisis.[[In-content Ad]]