Reply With Quote
Soros outlines good bank/bad bank strategy, a role for the IMF, structural weakness for the Euro:
http://www.irishtimes.com/newspaper/...923372970.html
The game changer
By George Soros
Published: January 28 2009 19:55 | Last updated: January 28 2009 19:55
Into the abyss: the Lehman European headquarters in London when the bank collapsed last SeptemberIn 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.
But worse was to come. Lehman was one of the main market-makers in commercial paper and a large issuer of these short-term obligations to boot. Reserve Primary, an independent money market fund, held Lehman paper and, since it had no deep pocket to turn to, it had to “break the buck” – stop redeeming its shares at par. That caused panic among depositors: by Thursday a run on money market funds was in full swing.
The panic then spread to the stock market. The financial system suffered cardiac arrest and had to be put on artificial life support.
How could Lehman have been left to go under? The responsibility lies squarely with the financial authorities, notably the Treasury and the Federal Reserve. The claim that they lacked the necessary legal powers is a lame excuse. In an emergency they could and should have done whatever was necessary to prevent the system from collapsing. That is what they have done on other occasions. The fact is, they allowed it to happen.
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.
First, there is an asymmetry in the risk/reward ratio between being long or short in the stock market. (Being long means owning a stock, being short means selling a stock one does not own.) Being long has unlimited potential on the upside but limited exposure on the downside. Being short is the reverse. The asymmetry manifests itself in the following way: losing on a long position reduces one’s risk exposure while losing on a short position increases it. As a result, one can be more patient being long and wrong than being short and wrong. The asymmetry serves to discourage the short-selling of stocks.
The second step is to understand credit default swaps and to recognise that the CDS market offers a convenient way of shorting bonds. In that market the asymmetry in risk/reward works in the opposite way to stocks. Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential; by contrast, selling credit default swaps offers limited profits but practically unlimited risks.
The asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds. When an adverse development is expected, the negative effect can become overwhelming because CDS tend to be priced as warrants, not as options: people buy them not because they expect an eventual default but because they expect the CDS to appreciate during the lifetime of the contract.
No arbitrage can correct the mispricing. That can be clearly seen in US and UK government bonds, whose actual price is much higher than that implied by CDS. These asymmetries are difficult to reconcile with the efficient market hypothesis, the notion that securities prices accurately reflect all known information.
The third step is to recognise reflexivity – that is to say, the mispricing of financial instruments can affect the fundamentals that market prices are supposed to reflect. Nowhere is this phenomenon more pronounced than in the case of financial ins utions, whose ability to do business is dependent on confidence and trust. That means that “bear raids” to drive down the share prices of these ins utions can be self-validating. That is in direct contradiction to the efficient market hypothesis.THE SOROS INVESTMENT YEAR:Putting these three considerations together leads to the conclusion that Lehman, AIG and other financial ins utions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other. Unlimited shorting was made possible by the 2007 abolition of the uptick rule (which hindered bear raids by allowing short-selling only when prices were rising). The unlimited selling of bonds was facilitated by the CDS market. Together, the two made a lethal combination.
Positions I took were too big for ever more volatile markets
Although I positioned myself reasonably well for what was coming last year, one thing I got wrong cost me dearly: there was no decoupling between markets of the developed and developing worlds.
Indian and Chinese stocks were hit even harder than those in the US and Europe. Since we did not reduce our exposure, we lost more money in India than we had made the year before. Our Chinese manager did better by his stock selection; we were also helped by the appreciation of the renminbi.
I had to push very hard in my macro-account to offset both these losses and those incurred by our external managers. This had its own drawback: I overtraded. The positions I took were too large for the increasingly volatile markets and, in order to manage my risk, I could not go against the market in a big way. I had to try to catch minor moves.
That made it difficult to maintain short positions. Although I am an experienced short-seller, I got caught several times and largely missed the biggest down-draught, in October and November.
On the long side, where I stuck to my guns, I lost an enormous amount of money. I was impressed by the potential in the new deep-water oilfield in Brazil and bought a large strategic position in Petrobras, only to see it decline by 75 per cent at one point in time. We also got caught in the developing petrochemical industry in the Gulf.
We did get out of our strategic long position in CVRD, the Brazilian iron ore producer, in time for the end of the commodity bubble and shorted the other big iron ore groups. But we missed an opportunity in the commodities themselves – partly because I knew from experience how difficult it is to trade them.
I was also slow to recognise the reversal of fortune for the dollar and gave back a large portion of our profits. Under the direction of my new chief investment officer, we did make money in the UK, where we bet that short-term interest rates would decline and shorted sterling against the euro. We also made good money by going long on the credit markets after their collapse.
Eventually I understood that the strength of the dollar was due not to people choosing to hold dollars but to their inability to maintain or roll over their dollar obligations. In a very real sense the strength of the dollar, like the fever associated with sickness, was a measure of the disruption of the financial system. This insight helped me to anticipate the downturn of the dollar at the end of 2008. As a result, we ended the year almost meeting my target of 10 per cent minimum return, after spending most of the year in the red.
That is what AIG, one of the most successful insurance companies in the world, failed to understand. Its business was selling insurance and, when it saw a seriously mispriced risk, it went to town insuring it, in the belief that diversifying risk reduces it. It expected to make a fortune in the long run but it was destroyed in short order.
My argument raises some interesting questions. What would have happened if the uptick rule on shorting shares had been kept, in effect, but “naked” short-selling (where the vendor has not borrowed the stock in advance) and speculating in CDS had both been outlawed? The bankruptcy of Lehman might have been avoided but what would have happened to the asset super-bubble? One can only conjecture. My guess is that the bubble would have been deflated more slowly, with less catastrophic results, but that the after-effects would have lingered longer. It would have resembled more the Japanese experience than what is happening now.
What is the proper role of short-selling? Undoubtedly it gives markets greater depth and continuity, making them more resilient, but it is not without dangers. As bear raids can be self-validating, they ought to be kept under control. If the efficient market hypothesis were valid, there would be an a priori reason for imposing no constraints. As it is, both the uptick rule and allowing short-selling only when it is covered by borrowed stock are useful pragmatic measures that seem to work well without any clear-cut theoretical justification.
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 ac ulated debt can sink the banking system and push the economy into depression. That is what needs to be prevented at all costs.
It can be done – by creating money to offset the contraction of credit, recapitalising the banking system and writing off or down the ac ulated debt in an orderly manner. They require radical and unorthodox policy measures. For best results, the three processes should be combined.
If these measures were successful and credit started to expand, deflationary pressures would be replaced by the spectre of inflation and the authorities would have to drain the excess money supply from the economy almost as fast as they had pumped it in. There is no way to escape from a far-from-equilibrium situation – global deflation and depression – except by first inducing its opposite and then reducing it.
To prevent the US economy from sliding into a depression, Mr Obama must implement a radical and comprehensive set of policies. Alongside the well-advanced fiscal stimulus package, these should include a system-wide and compulsory recapitalisation of the banking system and a thorough overhaul of the mortgage system – reducing the cost of mortgages and foreclosures.
Energy policy could also play an important role in counteracting both depression and deflation. The American consumer can no longer act as the motor of the global economy. Alternative energy and developments that produce energy savings could serve as a new motor, but only if the price of conventional fuels is kept high enough to justify investing in those activities. That would involve putting a floor under the price of fossil fuels by imposing a price on carbon emissions and import duties on oil to keep the domestic price above, say, $70 per barrel.
Hank Paulson, former Treasury secretary (left), and Ben Bernanke, Federal Reserve chairman, arrive for their November testimony to CongressFinally, the international financial system must be reformed. Far from providing a level playing field, the current system favours the countries in control of the international financial ins utions, notably the US, to the detriment of nations at the periphery. The periphery countries have been subject to the market discipline dictated by the Washington consensus but the US was exempt from it.
How unfair the system is has been revealed by a crisis that originated in the US yet is doing more damage to the periphery. Assistance is needed to protect the financial systems of periphery countries, including trade finance, something that will require large contingency funds available at little notice for brief periods of time. Periphery governments will also need long-term financing to enable them to engage in counter-cyclical fiscal policies.
In addition, banking regulations need to be internationally co-ordinated. Market regulations should be global as well. National governments also need to co-ordinate their macroeconomic policies in order to avoid wide currency swings and other disruption.
This is a condensed, almost shorthand account of what needs to be done to turn the global economy around. It should give a sense of how difficult a task it is.
The writer is chairman of Soros Fund Management and founder of the Open Society Ins ute. These are extracts from an e-book update to The New Paradigm for Financial Markets – The credit crisis of 2008 and what it means (PublicLuck_The_Fakers_Affairs Books, New York)
Last edited by Winehole23; 01-29-2009 at 01:07 PM.
Soros outlines good bank/bad bank strategy, a role for the IMF, structural weakness for the Euro:
http://www.irishtimes.com/newspaper/...923372970.html
http://www.iht.com/articles/2008/01/...vos.php?page=1"The current crisis is not only the bust that follows the housing boom," Soros said. "It's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency."
Soros.
Made a billion dollars shorting the pound sterling in 1992. Returned 10% to his investors last year.
Whatever you think of the guy's politics (I hate them), he's no dummy when it comes to money.
I thought that was an excellent read and a very smart way of dealing with this crisis.
I have always said that buying toxic CDO's was the foundation of any recovery. Instead King Paulson decided to buy preferred shares, WTH?
Though I disagree with Soros in other areas, IMO he's close to being on target here.
The OP gives insight to the thinking of one of the world's foremost vulture capitalists.
Why does my Distrust Meter ring its loudest when reading/listening to investment bankers and their ilk?
This guy doesnt give two s about America. He cares only about stable, global markets. Talking about periphery countries being affected (i hate those two words and their uses) disproportionately to the 'offending' nations of origin.
My tolerance for the world's reliance on the US is at its end. I had read recently (maybe an article from you, Wine) that the American economic model wherein the populace/consumer accounts for almost 70% of the GDP is unheard of in world history. That it is actually the exact opposite that other countries strive for.
So, when your economy is based on your people consuming, you have economic stimulus packages passed by our government in some weird attempt at forcing people to buy .
This makes no sense whatsoever, and the fact that we as a country turn to the indivduals who caused this mess for answers is appalling.
ES said it best, any country worth its salt would have swung these ers by their necks for this debacle. We are a capitulant mass of faux philosophers with neither the spine or temprament to permanently effect change.
Are you not creeped out by his suggestion of a role for the IMF and a mechanism for global economic coordination?
I agree about 100% with this.
I pretty much resemble that remark. The problem isn't hard to understand, but the will to change it is definitely lacking.
The problem is, where do you get the revolutionary mass, and who do you shoot at?
I never said I agreed with everything, but his ideas of short-term stabilization are solid.
Long-term I have my own ideas which I plan on posting soon.
I know youre speaking to 2cents here....
In a word, yes. That is what sparked my outrage.
The entire OP article is not one of American health and well being, it is one of financial health and well being. Two very different concepts with little to no relationship.
This guy isnt advocating the turn-around of the American economy, hes proposing ways to stabilize banking ins utions and their global ilk. Sure, doing so on the backs of the American taxpayer will hopefully, eventually stabilize and bring us back to status quo.
But who the wants status quo?! Who?
Oh, right. The banks. Of course! They want unlimited profit with limited exposure. Only when they do expose themsleves, its sold as an American responsibility to prop them up. I call bull .
Obama is what Obama is. Another politician with no spine to make the country a better place.
stimulus packages. TARP. auto bailouts. bailouts in general. Raise taxes, pay down the debt, everyone lives less than they had for about 10 years, boom, everything rights itself.
But that plan doesnt get you and your dumb ing cronies elected in the next cycle. I love my country, I hate my government. Obama's pen should not be touching any stimulus package or bailout, but it is. And it will.
Again and again and again and again. How ing pathetic, even nearing evil is that we as a generation find it acceptable to pass our incredible, insurmountable debt onto our children and grandchildren?
This generation....our generation had better never say an ill word to the young. Nothing about "working hard" or "saving money" or some other meaningless tripe your grandparents bestowed upon you.
You ed them. We ed them. Their position and lot in life is directly correlated to us. It literally, and I am not kidding, makes me sick to be apart of, even indirectly (or should I say, representatively).
There's a question of timing about this, but I'll repeat my pledge to vote for any candidate that promises to raise taxes and cut benefits. It might take longer than ten years though.
Not that it's any consolation, we'll have to pay the piper too. But yes, the perfidy is colossal, unconscionable and probably unfixable at this point. It's more than a damn shame. It's a generational crime.
Aristotle once said that there is no virtuous life in a bad state, because we are the molecules that sustain the evil social totality.
Revolutionary Mass: Never going to happen. So long as American Idol is on every Wednesday, all is right in your typical Americans world.
No, a revolution would require...an event. Lets leave it at that.
Who to Shoot At: Thats incredibly simple. Murlocs and Eloise, pick a side.
So be it. I for one am not beholden to my possessions.
I like that. I like that a lot. Consider your wisdom (and Aristotle's) lifted by me.
http://www.wowwiki.com/Murloc
Is this what you meant by Eloise?:
http://www.videosurf.com/video/elois...-show-55198796
So be it. I for one am not beholden to my possessions. I have no interest for or in the welfare and wealth of my countrymen, nor my own. I believe everyone is en led to that which they earn (ie not socialism). But what we see today is an abortion of capitalism, with the concentrated hands of wealth begging at the feet of the taxpayer. As if we owe them something, that our country owes them something.
You corrupt s, just because you can do it (CDSs, short-selling, etc) doesnt mean you should do it. But because your compe ors did it, in order to compete you were "forced" to. Well, lets rewind 15 years ago and reconsider your decision to delve into such obvious high-risk, low-ethics business practice and ask "How long will this ride last for your less-than-above-board compe ors?"
There is no feasible excuse for the conduct of our government and our financial systems of the past 30 years, both implicit to this....this, tragedy. I am of the opinion that public office affords one with so much power and influence, that with said power comes increased responsibility. Death to those officials guilty of comformity or incompetency.
They held us hostage at banks, theyve held us hostage with taxes, with education, with personal consumption and law enforcement. A para-military force masquerading as Police Officers now enforces the rule of law. Their law.
Its time to hold them hostage to us. Do your job. Represent the people, not the business sector. Represent the citizens of this great country, not the international interests of corporation conglomerates and banking ins utions to get the 2.5 points needed to turn one investment 3 fold. Africa, the Middle East, India, China, Mexico...all of these people are exploited in the name of profit for multi-national companies who currently have their collective hand open to the taxpayer charity.
They pass this notion off as "How do you think you get your goods so cheap?" as if this is a sound line of reasoning or that it even has any bearing on the argument. No, its done to maximize profits, period. The price of goods is a tertiary effect to the sole purpose.
Anyway, my indignation is all used up today. I have had similar, less vitriol-laced conversations such as this with those close to me. All I get is weird looks and subtle laughs, because their existence isnt predicated on the acts of government or business.
They take their job loss as "oh well, its the economy". They take their 401k hit as "Damn, I should have moved my money". They dont see unemployment numbers until they accidentally watch the news after the latest syndicated episode of "Friends" ends.
They are blind because they choose to be, because to take an active interest in the world around them and its implications on you and your family is "depressing" and theyre already taking Zoloft for that. Either to trusting or willfully ignorant.
And that, that fact, is the greatest triumph of the power-brokers of this world. They have quite literally broken the spirits of Americans through regular, unimportant entertainment dosages and addicted them to the idea that theyre not capable of understanding the scope and pattern of government.
It broke my heart when I was old enough to find out that it worked. It still breaks my heart.
Damnit. In my haste, I misspelled it.
Morlocks and Eloi.
EDITED: jesus h. christ, misspelled it again.
Last edited by DarkReign; 01-29-2009 at 03:32 PM.
Well then, you're still human. It hasn't pacified you, and your anger hasn't turned you into a monster yet.
That's a good place to be, IMO. Your ideals are worth the pain. Throw them away, and you throw yourself into the dust bin of history.
Give em , DarkReign!
Damn, I am sorry for my worthless post in this thread. This was a great exchange between Winehole and DarkReign. I'll start paying attention a lot more to ya'lls posts so I can learn more.
Now THAT'S a post.
that im glad lehman and any hedgefund that was buying and shortselling oil can go eat a for driving the price up last year.... them.
I wish more of the banking system had failed. Maybe then smaller banks who actually knew what the they were doing could have expanded into their place.
The wreckage would've been politically unacceptable.
The thing that burns me up, it might still be, but by that time we'll be $trillions poorer than we really needed to be.
It would only have been unacceptable because people wouldn't have understood why it was happening. People "get" the housing failure so they accept the economy is bad, but they don't realize that it was only a symptom and not the disease.
If people really understood the brink the US is actually teetering on this "stimulus" would be unacceptable as well.......and not for the lame ass reasons most republicans are citing as reasons to oppose it either.
There are currently 1 users browsing this thread. (0 members and 1 guests)
Posting Permissions
