Next to Warren Buffett, George Soros is probably the next well known financier and philanthropist. Unlike Buffet, he became well known and rich via speculation and making huge risky bets. He was famous for making 1 billion dollars profit against the British pound two decades ago. Less well known are the facts that he was educated as an economist and a well studied and self taught learner of that “dismal” science. The latest of the several books he has written on applied economics and finance is titled above.  Today at the Invitation of the MIT officef the President and the Economics Department, he gave the above titled informal conversation at MIT which was simultaneously webcasted [ http://web.mit.edu/events/soros   I don’t know how long this will remain on the web]. Here are the salient points he made

·1.The book is The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means (PublicAffairs, 2008) ISBN 978-1586486839.

·2.. The central thesis of his book is what he calls the “Reflexivity principle” and the major   structural difference between natural and manmade phenomena. He posits that because of the fact that human have deliberate choices which in turn has unintended consequences makes it impossible to predict accurately into the future.  Good ideas will be always be exploited to the point such that it doesn’t work anymore. Many of the financial mechanism are self reinforcing, exacerbated by misconception, leading to self destruction in the end. My interpretation as a control system theorists : these are vague, non-rigorous, but basically correct statements about

o   Inherent instability of some complex dynamic systems – interactions of dynamics and feedback

o   Inadequacies of mathematical game or decision theory to model real situations

                It is amazingly insightful for one lay person to perceive these.

3. On social philosophy he admires Karl Popper’s controversial book “open society and her enemies”. He believes the one basic mistake made by K. Marx is to ignore in his utopian view that human beings are motivated by incentives.

4. Now to the current financial meltdown and the super bubble. This is my interpretation of his take on this

·5. He trace the origin to the expansion of credit and the use of leverage (for the lay person: leverage is to borrow money at fix interest to make bets with the hope of amplifying your profit when you bet right. Leverage works in reverse when you bet wrong of course) that started more than 25 years ago.  The misconception is that financial markets are self regulating and will always correct itself.

·6. When you let local banks to sell the mortgage they underwrote via “securitization” (i.e., sell it as a commodity just like  stocks and bonds), you remove the incentive for the banks to be careful against lending money to people who cannot afford the mortgage. This plus fancy packaging, pseudo insurance (the CDS I explained in my Wall Street Crisis (III) article http://www.sciencenet.cn/blog/user_content.aspx?id=43553), and leveraging beyond reason led to the current super bubble and meltdown.

7. Initially, credit expansion and leveraging was actually good for the US on a cost-benefit basis for a while, (e.g., it enabled the willingness of other countries to lend US money.) But this cannot be sustained forever.

·8.  He says that the market is amoral which is why we need politics and morality to device rules and to regulate the system.

·9.   He prescribe steps to reform and repair the current system. But these are too technical to be reported. You are welcomed to view the video yourself.

 

For me, the fascinating things is to see the interplay of the basic theoretical ideas of economics and game theory against the realities of practical finance. Soros may not have formal training but certainly have insight in the former; but he has the conviction and knows how to use these insight in the latter. He deserves to be rich.