'The Crash of 2008 and What It Means' by George Soros 58 comments
Shiv Kapoor
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Bubbles - Reflexivity & Contamination
“The Crash of 2008 and What it Means”, by George Soros is painfully difficult to read; the concept of reflexivity is not easy to understand; it is abstract and frankly, not very well written. But it has profound implications; it explains an important theory. Equally, it lets you into the mind of a highly successful speculator.
If you take the time to read it, do so not for pleasure. Do so in the quest of knowledge. After plodding through it slowly, and re-reading parts to try and understand what it is all about, I can say I believe I have gained some insight into the world of bubbles and into the marvelous mind of the man I see as the world’s greatest speculator.
First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.
Bubbles thus have two components: a trend that prevails in reality and a misconception relating to that trend. The simplest and most common example is to be found in real estate. The trend consists of an increased willingness to lend and a rise in prices. The misconception is that the value of the real estate is independent of the willingness to lend. That misconception encourages bankers to become more lax in their lending practices as prices rise and defaults on mortgage payments diminish. That is how real estate bubbles, including the recent housing bubble, are born. It is remarkable how the misconception continues to recur in various guises in spite of a long history of real estate bubbles bursting.” - George Soros – The Crisis & What to Do About It.
Below I recap the workings of an idle mind after reading - “The Crash of 2008 and What it Means”
The theory of reflexivity is very hard to understand. It is something Mr. Soros understands by instinct; but it remains very difficult to express and perhaps too abstract for me to understand clearly. What is of critical importance in this theory is that it explains why traditional equilibrium economics fails; it explains very simply why markets and asset values are in constant disequilibrium.
It explains well how the misconception can reinforce the primary trend to create a bubble; for example, in Indian real estate there is a clear primary trend from a fundamental view point; massive liquidity/leverage is attracted because of the strong fundamentals. And it is this liquidity/leverage (the misconception) which drives asset prices and reinforces the primary trend. There comes a point in time when the asset prices react more because of the misconception than because of the primary trend. When the misconception is discovered, the bubble is pricked and asset prices rapidly decline to equilibrium and then far below.
The timing of discovery of the misconception is subject to the vagaries of human nature – I suspect the most appropriate time is when capacity created is well in excess or present and near future demand. I say that this bubble has yet to burst because even today the real estate companies are able to leverage their balance sheets; during recent years, leverage came in the form of debt and by way of over-priced IPOs. Today, the leverage continues – for now it is mainly in the form of new equity issued to qualified institutional investors; and this is good as it repairs badly damaged balance sheets – what remains to be seen is whether this ability to leverage the balance sheet will strengthen the misconception/misrepresentation and continue to drive the bubble in valuation of Indian residential real estate (please read George Soros's Reflexivity & the Indian Real Estate Bubble for more complete details).
Until now, people with vision have had the ability to understand and accept that the market is in constant disequilibrium. So far as I am aware, this theory is the only one which seeks to understand why. Understanding why bubbles are created and why they burst is very important. In a sense, it is more important than the bubble or its bursting is; a solution shall arise only from an understanding of the underlying cause. Because the cause is more often than not human nature and the play off between greed and fear; it is my view that any solution will have to be enforced through policy and regulation.
In my view, if there is an ounce of sense amongst the academic community of economists, they will accept that economic theory is more art than science. The need to draw insight from human psychology and understand that cause is important. And then explain how human nature interacts with quantitative economics. I continue to see traditional equilibrium economics as very important, but feel there is a great need to understand why the markets are always in a constant state of disequilibrium. Simple acceptance of the fact that markets are in a constant of disequilibrium is a great first step. The second step is seeking to understand why.
In a sense, reflexivity can be predictive - a search of a primary trend together with a quest to identify misrepresentations/misconceptions can point to the direction in which asset values might go. I do not however see it as being predictive as to when direction might change. It is not quantitative, because it cannot predict how high asset values might go or how low they might fall. The misconception can be recognized, but for a bubble to burst, the fact that it is a misconception must be widely accepted - until then the herd mentality and psychology of markets will drive the bubble onwards - the misconception continues to work until it is too late. Yet, it is not the predictive characteristics of reflexivity that interests me. What does interest me, using this concept as a means to understand bubbles; from such understanding, comes two advantages. The first is an ability to exploit mispricing in the markets and profit from it while it exists; the second is far more important – the quest for policy solutions which will reduce the extent of mispricing in markets and promote better stability, so necessary for sustained long term growth.
Once a bubble bursts is when things get interesting. They say that the bull of the last economic cycle rarely leads the next expansion. This makes sense. The last bull is normally in bubble formation until it pricks; once it pricks, there is recognition of the misconception. The sector will run closer to fundamentals (and below) during the next economic cycle. My own theory of contamination, accepts bubbles. It pre supposes that the bubble contaminates sectors other than the sector (though to a lesser degree) which is the cause of the bubble.
When the primary bubble bursts, the contamination spreads across all sectors. And it is these sectors where the best values shall be available. For example during the most recent bubble we have two cause sectors - financial services and consumer discretionary (including real estate). We had energy and basic materials as heavily contaminated sectors; the fundamentals (primary trend) are strong and remain so. They did get contaminated by liquidity/leverage/derivatives; but when the bubble burst, the sectors fell well below fundamentals (equilibrium economics suggests oil prices at $35 were well below the marginal cost of production; which is the point of equilibrium when it equals marginal revenue). In my view this is a repaired contamination and I expect these sectors to lead the next expansion because the primary trend remains intact; unfortunately for financial services and consumer discretionary products the bursting of the bubble has damaged the primary trend; it will take a long time to repair.
Finally, there is a case for bubbles as being essential for development. There is a case to be made for understanding capacity in the context of time. For example, during the internet bubble, miles of cable were laid; this resulted in the creation of huge over capacity. Once the bubble burst, the over capacity was financially worthless. Yet, the communications revolution shall be built on those very cables. Capacity creation in a very short period of time instead of over a long period of time is what caused this bubble. The collapse in values caused by over capacity will drive a new phase of development.
I suspect that something similar is occurring in emerging markets today. The need is humongous and across the board. In a sense, it is the creation of capacity which will convert the need into actual demand; for in the process of creating capacity, income levels to demand use of the capacity created will arise. This will drive the next phase of capacity creation. But there will come a point in time when liquidity will drive capacity expansion ahead of current need (though well short of tomorrows need). And this will cause a painful contraction, until the excess capacity, now at more economically viable prices shall drive the next phase of expansion.
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This article has 58 comments:
I prefer to think of the markets as constantly "seeking" equilibrium rather than in constant disequilibrium. More transparency, more attention to fundamentals, and more widespread financial knowledge would create an investor class that lessens the volatility.
The lack of an equilibrium shocks no one presumably. The markets are working towards equilibration in the short run but may never reach the objective. As for his explanation of how disequilibrium can lead to bubbles, he has not offered any data to support his claims of its explanatory or descriptive powers. As theory goes his work is best classified as descriptive, but not predictive in any sense. In short, he is not likely to receive a Nobel prize for his thinking. His risking is something else and worth some further research possibly.
On Jul 10 03:51 PM Cardio wrote:
> I enjoyed the article on reflexivity. Question: If you attempt to
> mitigate the effects of the human element in the markets through
> policy, how do you eliminate the human element from those making
> and enforcing the policy? The theory becomes quite convoluted at
> that point.
>
> I prefer to think of the markets as constantly "seeking" equilibrium
> rather than in constant disequilibrium. More transparency, more attention
> to fundamentals, and more widespread financial knowledge would create
> an investor class that lessens the volatility.
In the longer term, the exit of the Pound from the constraints of the ERM ushered in a period of prosperity as the lower exchange rate proved to be hugely beneficial for the economy.
On Jul 11 01:34 AM robert.b.ferguson wrote:
> First let me say that I did not read the synopsis just as our legislators
> didn't read the bills they voted for. Soros is responsible for the
> ruination of the British pound and the election of Barak Obama. Follow
> the money.
The answer is simple. Require lending be base on cash flow analyis. Have a non interested 3rd party determine annually if that cash flow is at risks ( unlike the pay for play ratings agencies MBIA etc ).
The result. In good times bubbles have trouble developing send lending disipates as assets become overvalued ( opposite of present situation where as Reflexivity describes, higher prices, more lending ). In slowdowns lending becomes more attractive as valuations are low compared to cash flow.
You could still lend otherwise but it would have to be outside the protected umbrella. i.e. it would be labeled as speculative and yields and down payments would be correspondingly higher and it would need to be segregated from the rest of the financial system. No buying loan insurance. If the loan fails it fails alone.
Some will argue that this is interference with the free markets. Does not a gardener interfere when he weeds his garden ? Does not the tomato still thrive and grow ? Not despite the gardeners efforts but because of it.
The answer is simple. Require lending be based on cash flow analyis. Have a non interested 3rd party determine annually if that cash flow is at risks ( unlike the pay for play ratings agencies MBIA etc ). It can be done re: Egan Jones.
The result. In good times bubbles would have trouble developing since lending would disipate as assets become overvalued ( opposite of present situation where as Reflexivity describes, higher prices, more lending ). In slowdowns lending becomes more attractive as valuations are low compared to cash flow.
You could still lend otherwise but it would have to be outside the protected umbrella. i.e. it would be labeled as speculative and yields and down payments would be correspondingly higher and it would need to be segregated from the rest of the financial system. No buying loan insurance. If the loan fails it fails alone.
The end result would be a much tamer business cycle and if successfully implemented the end to financial panics and crisis. If that sounds pollyanish, consider this ... before the 1930s depressions and panics were common. Then changes were made to make the system more stable such as Glass Steagall which seperated lending and investment houses and Mark to Market accounting. Both reinstated in recent years to disasterous results. We haven't had anything resembling a depression until now.
Some will argue that this is interference with the free markets. Does not a gardener interfere when he weeds his garden ? Does not the tomato still thrive and grow ? Not despite the gardeners efforts but because of it.
you are correct. the books is painfully difficult to read;
I would pass on Soros book - it is at the bottom of the list of investment books to read
The multiplier effect takes hold when the financial and/or popular media make the public increasingly aware of a trend-to-become-a-bubble. Bubbles can only happen when enough people become aware and want to jump on the bandwagon, causing the trend to exponentiate. Otherwise, a trend remains linear and runs its natural course.
So communication media play an important role in the development of bubbles, perhaps unwittingly, perhaps not, perhaps through advertising, perhaps through news stories, perhaps just through word of mouth (if you've never heard of a tulip there is no reason to one).
I just wonder what the financial world has in store for us with Twitter and even more sophisticated instant communication tools to become available in the future. "What are people investing in RIGHT NOW?!" Will we have more transparent information availability? Will we have increasing amounts of misinformation to manipulate markets? Will we have intraday bubbles? Does George Soros Twitter?
Yes Soros supported Obama, I'll bet he is as unhappy as I am with his choice.
This is a guy I have never understood why people hate. he takes his position, makes it public and explains why. rogers, Buffett, Soros, einhorn,shiff, Faber. along with others. they have been successful over many years doing their own thing and bucking tradition. These folks haven't destroyed the economy, but have recognized fundemantal mismatches between asset prices and the real macro issues. they do not get paid by building bubbles for you to invest in (wall street), nd then pulling the rug out from under you.
soros pretty much warned many people that the world was in crisis, he came out of retirement, but people didn't listen. Is that his fault?
People don't like soros because he bucks the establishemnt. He has done amazing things for eastern Europe, and actually has some principles.
Thsi guy isn't some way street banker.
On Jul 11 01:34 AM robert.b.ferguson wrote:
> First let me say that I did not read the synopsis just as our legislators
> didn't read the bills they voted for. Soros is responsible for the
> ruination of the British pound and the election of Barak Obama. Follow
> the money.
May I safely assume that you're one of the people who blame short sellers for all the ills of the financial world? I suppose it makes life easier to have a clear-cut "bogey man" when instigating a witch-hunt.
As pointed out above, Soros was merely one of a number who profited from the meltdown of sterling. As to his support of Obama,...hey, the guy's human!
On Jul 11 01:34 AM robert.b.ferguson wrote:
> First let me say that I did not read the synopsis just as our legislators
> didn't read the bills they voted for. Soros is responsible for the
> ruination of the British pound and the election of Barak Obama. Follow
> the money.
Now combine this understanding of human nature with the fact that humans are herd animals, or, more accurately, a combination of herbivore and carnivore, and so are herd animals that hunt in packs.
Using Freud's metaphors, the center of the human psyche is the Id, irrational and power seeking; the intellect is the willing good servant of emotion and not vice versa. Emotion is the foundation of the self and "Cogito ergo sum" childish nonsense.
Humans tell stories to each other and these stories propagate in accordance with the times. People tell stories about reality, human nature, etc. and are believed on the basis of desire to believe them true. Concrete reality intrudes; the more intrusive reality becomes the more the emotional self demands "understanding" of the rational self and the more frantic become the rationalizational effort.
Really, this is all that need be said. We all individually respond to this human reality in accordance with our character.
Shiv Kapoor said
>the misconception continues to work until it is too late. Yet, it is not the predictive
>characteristics of reflexivity that interests me. What does interest me, using this concept as a
>means to understand bubbles;
I don't know that we can ever prevent the formation of bubbles, but trying to figure out what causes their eventual collapse would enable us to "prick" them early on, minimizing the damage to other markets.
frost said:
>The multiplier effect takes hold when the financial and/or popular media make the public
>increasingly aware of a trend-to-become-a-bubble. Bubbles can only happen when enough
>people become aware and want to jump on the bandwagon, causing the trend to exponentiate.
>Otherwise, a trend remains linear and runs its natural course.
Actually I think knowledge of a bubble exacerbates the situation. Even as people despise bubbles, they recognize that there is an opportunity cost for not participating.
In the context of the current meltdown, one of the difficulties he identified was that Greenspans notion of capitalism was misplaced where he assumed that large bank and hedge firms would act in their own self-interest. In reality, the agents of those companies acted in their individual self-interest - not the interest of the larger firms. He identified this as a mismatch which apparently can have massive consequences. For example, if you work at a hedge fund and your pay is based on 20% of the upside bets on billions of dollars in investments with no personal risk (other than looking for a new job), it is in your best interest to take massive bets with that money to maximize your own potential return.
In the constext of Soros work, however, the difficulties Soros describes can largely be attributed to Prospect Theory and the intereaction of the investors ideas and reality in the property markets (not the interaction of Prospect Theory and Regulators described above).
When thinking about economics it is important to remember that what we are talking about is human behavior. There are no 'objective' standards that humans must conform to. We can be irrational. Even our rationality is mutable: our ideas are affected by how we feel about things.
I think Soros' "reflexivity" idea can be simply stated. Market 'fundamentals' like PE ratios reflect the dominant attitude. In a rising market an index PE of 15 feels about right, but in a falling market an index PE of 8 might seem more appropriate. The fundamentals are not an objective standard, They are just another reflection of how the people who buy and sell feel at the time.
The 'equilibrium' is not some fixed state but is a movable standard. We hear about the 'new normal'. This can be thought of as a new equilibrium point, lower than the old optimistic one. Market behavior, which is individual people acting from their perceptions of reality, will concentrate around this new equilibrium point.
The weight of all those people sharing an economic attitude (optimism or pessimism) is self fulfilling. If people think the market is going down they sell, which drives the market down. If they think it's going up they buy, which drives prices up. Any widespread and longer duration economic attitude creates a new equilibrium point, a new normal, until sentiment changes and a new new normal begins to take shape.
I think this is what Soros means by 'reflexivity'.
On Jul 11 12:22 PM derryl wrote:
> Shiv wrote, "The theory of reflexivity is very hard to understand.
> It is something Mr. Soros understands by instinct; but it remains
> very difficult to express and perhaps too abstract for me to understand
> clearly. What is of critical importance in this theory is that it
> explains why traditional equilibrium economics fails; it explains
> very simply why markets and asset values are in constant disequilibrium."
>
>
> When thinking about economics it is important to remember that what
> we are talking about is human behavior. There are no 'objective'
> standards that humans must conform to. We can be irrational. Even
> our rationality is mutable: our ideas are affected by how we feel
> about things.
>
> I think Soros' "reflexivity" idea can be simply stated. Market 'fundamentals'
> like PE ratios reflect the dominant attitude. In a rising market
> an index PE of 15 feels about right, but in a falling market an index
> PE of 8 might seem more appropriate. The fundamentals are not an
> objective standard, They are just another reflection of how the people
> who buy and sell feel at the time.
>
> The 'equilibrium' is not some fixed state but is a movable standard.
> We hear about the 'new normal'. This can be thought of as a new equilibrium
> point, lower than the old optimistic one. Market behavior, which
> is individual people acting from their perceptions of reality, will
> concentrate around this new equilibrium point.
>
> The weight of all those people sharing an economic attitude (optimism
> or pessimism) is self fulfilling. If people think the market is going
> down they sell, which drives the market down. If they think it's
> going up they buy, which drives prices up. Any widespread and longer
> duration economic attitude creates a new equilibrium point, a new
> normal, until sentiment changes and a new new normal begins to take
> shape.
>
> I think this is what Soros means by 'reflexivity'.
On Jul 11 01:34 AM robert.b.ferguson wrote:
> First let me say that I did not read the synopsis just as our legislators
> didn't read the bills they voted for. Soros is responsible for the
> ruination of the British pound and the election of Barak Obama. Follow
> the money.
On Jul 11 01:18 PM H.J. Huneycutt wrote:
> Soros didn't support Obama, so there goes your theory (and credibility).
>
If that's your thinking, I wish you lots of luck in academia, as the markets might not be nice to you.
I agree with you though that reflexivity is simply another name for feedback loops.
On Jul 11 11:15 AM manya05 wrote:
> Reflexivity? most people would call it a positive feedback loop,
> and the concept is as old as control theory, which has been around
> for decades. Until you put some meat into it (a quantification that
> can be expressed in equations), it makes for nice cocktail conversation,
> but not much else.
See link:
www.icic.com/yang_yin_...
icic.com
On Jul 10 06:35 PM whidbey wrote:
> Reflexivity strikes most classical economist as unnecessary for most
> of the reasons Soros seems to find it so appropriate.
>
> The lack of an equilibrium shocks no one presumably. The markets
> are working towards equilibration in the short run but may never
> reach the objective. As for his explanation of how disequilibrium
> can lead to bubbles, he has not offered any data to support his claims
> of its explanatory or descriptive powers. As theory goes his work
> is best classified as descriptive, but not predictive in any sense.
> In short, he is not likely to receive a Nobel prize for his thinking.
> His risking is something else and worth some further research possibly.
On Jul 11 11:15 AM manya05 wrote:
> Reflexivity? most people would call it a positive feedback loop,
> and the concept is as old as control theory, which has been around
> for decades. Until you put some meat into it (a quantification that
> can be expressed in equations), it makes for nice cocktail conversation,
> but not much else.
Looking for investors buying this overblown paper to wake up one day and say this is crazy and it is..MarvinMBA
For me it has been helpful, especially lately since so many American developed theories, especially those from Harvard and University of Chicago, were proven to be not only wrong, but spectacularly wrong.
For us followers of Reflexivity watching Alan Greenspan admit that his Ayn Rand theories were inferior and wrong.
It is difficult for certain types of thinkers to understand, I've been following Mr. Soros for over 20 years, as a Hungarian there isn't a lot of heros and he fit the bill for me.
While his financial expertise is stunning, his support for Democracy and human rights through his annual $500 Million donations through his Open Society Institute is worth a Nobel and more. He is a great man and a hell of an investor.
Just take a look at nature, it evolves depending upon th environment, a late Spring means flowers bloom late. Reflecivity is a philosophy of changing your investment stategy and economic policy based on the current environment and ignoring rumours (especially the ones peddled in Starbucks) and looking at cold hard facts. Equities? Look at annual reports - ignore rumours. If the price of a stock goes up ask why. Don't jump on the band wagon just because it's moving - it could stop again! Quantitive easing looks like an unmitigated disaster, but it is really too early to tell. The value of currencies are relative to one another and relative to commodities. We can expect currencies to vary a little. But they will diminish in value against commodies. Precious metals and oil in particular. When you see the leaves falling from the trees you have a idea that winter is not far away. So reflexivity can help predict the future to a certain extent but can't tell you if next summer will be hot or not!
> For us followers of Reflexivity watching Alan Greenspan admit >that his Ayn Rand theories were inferior and wrong.
I can't make sense of this sentence. Greenspan gave up on using Ayn Rand theories when he started supporting socialist politcies of the Democratic Party anyway.
While you may be correct, its a positive feedback loop, the conclusion that, unless it can be expressed in a model, its not worth serious discussion as a concept wrong. While quantitative analysis has its place as a tool, its Achilles heels is that it presumes the ability to know all the variables that should be included in the model and the exact nature of their interrelationship.
In reality, the equation is far to complex to express accurately. Need proof? Notice how those over reliant on quant methods got their keysters handed to them the worst in the downturn. Those who properly understood the 'theories' of bubbles (especially Austrian economist, avoided the drop, sans equations.
So, continued good luck with that approach.
On Jul 11 11:15 AM manya05 wrote:
> Reflexivity? most people would call it a positive feedback loop,
> and the concept is as old as control theory, which has been around
> for decades. Until you put some meat into it (a quantification that
> can be expressed in equations), it makes for nice cocktail conversation,
> but not much else.
And the only reason he supported Obama was opposition to the war in Iraq? How do you square that with Soros' appetite for "radical change".
Soros is a leftist, a statist and an enemy of freedom everywhere.
Soros, Obama and the Art of the Hedge January 23, 2008, 9:59 AM, International Herald Tribune.
”I personally support Obama, but I don’t have any particular relationship,” said Mr. Soros…Mr. Soros did help play host at a fund-raiser for Mr. Obama at the home of Paul Tudor Jones II, another prominent hedge fund manager, in May.)…Mr. Soros added that he had ”very high regard” for what he depicted as Mrs. Clinton’s statesmanlike qualities. ”I prefer Obama because I think he would bring more radical change,” he said.
Soros-Funded Democratic Idea Factory Becomes Obama Policy Font By Edwin Chen Bloomberg.com 11/18/08
”…Thanks in part to funding from benefactors such as billionaire George Soros, the Center for American Progress has become in just five years an intellectual wellspring for Democratic policy proposals, including many that are shaping the agenda of the new Obama administration….”
On Jul 11 01:40 PM H.J. Huneycutt wrote:
> Or at least, Soros didn't put public weight behind Obama.
By the end he was spouting a bunch of nonsense to a herd of nodding heads.
Rand was proven wrong when she died of lung cancer while railing against government intervention into consumer products
On Jul 12 10:53 AM tonym wrote:
> On Jul 11 08:30 PM joes wrote:
When there is no intrinsic supply and demand of a good (shares, bonds and deriviatives), equilibrium is unacheivable; pricing remains dynamic. How laughable would it be if when you shopped for groceries the prices of items gyrated up and down, second by second? There is a profound difference between financial markets and goods/services markets. The difference is MOOD (limbic greed/fear) pricing vs THINKING (neo cortex rational valuation).
Bubbles end when insolvency overtakes credit creation in the dynamic market place of downstream monetary creation.
A de-facto tax cut for American motorists. Each $1 per barrel drop in oil increases U.S. GDP by $100 billion per year and every 1 cent decline in gasoline increases U.S. consumer disposable income by $600 million per year.
Just a little FYI:
Reflexvitity is not an English word.. It is a neologism.
BTW, I have a PhD.
That said, how did Soros do during the 2008 debacle? I mean did he make money or not? Suspect he lost bundle as well so he writes book on concept known for long time with new name called "reflexivity"?
By the way Soros is now bullish on Chinese stocks after 70% run up. Bet he acquired quite a bit during the run up and about to sell it to suckers retail investors.
The post's author may be interested in going straight to the source: Sir Karl Popper. His book "Conjectures and Refutations" is an excellent way to get a feel for what shaped Soros' thinking the most. It's a great book, broken into fairly digestible chapters, and skillfully written.
On Jul 11 01:34 AM robert.b.ferguson wrote:
> First let me say that I did not read the synopsis just as our legislators
> didn't read the bills they voted for. Soros is responsible for the
> ruination of the British pound and the election of Barak Obama. Follow
> the money.
When you have a prolonged period of low interest rate, the so-called real estate market bubble (similarly stock market bubble) is actually RATIONAL!
Suppose you have an apartment that can be rented out at $1,400 a month and hence $16,800 a year.
If the market believes that the long-run interest rate is 1%, the present value perpetuity of the stream of rent income is $1,680,000. That is the apartment's "fair" value is about $1,680,000.
If the market believes that the long-run interest rate is 5%, the present value perpetuity of the same stream of rent income is worth only $336,000. That is the apartment's "fair" value is only about $336,000.
If the Fed keeps the interest rate low for a long while, any so-called bubble is only the result of rational computation from some FIN 101 theory in finance.
Mr. Greenspan correctly contained the internet bubble by flushing the stock market with liquidity and low interest rate. However, he did not have any exit plan. The right time for raising the interest rate steadily back from 1% to 5% should have been the period of 2003-2006. Instead, it waited until Dr. Bernanke finally realized that there was a possible bubble. Bernanke tried to correct the bubble by raising the interest rate, but It was already too late!
The U.S. should have a minor bubble burst in 2006, instead of a major bubble burst in 2008. Thanks to Mr. Greenspan, a small financial crisis had turned into a financial tsunami.
Now, the interest rate is back to historical low. Is there an exit plan? The real estate prices in NYC was down but not by a sufficient amount. What will happen when the interest rate rises again?
Monetary policy can only contain a bubble, not correct it. You want the bust to go away? You better improve the productivity of the economy. Promoting speculative activity by lowering interest rate further won't work!
On Jul 10 10:26 PM Shiv Kapoor wrote:
> I agree with your observation but feel that policy can help ensure
> transparency and information availability which will ensure better
> knowledge of fundamentals. Since policy always comes after an event,
> their is an opportunity to understand and address causation. Because
> of humans being involved, it is more likely that policy will over-react.
>
>
> On Jul 10 03:51 PM Cardio wrote:
On Jul 12 10:06 PM rosey99 wrote:
> Interesting article. After reading "The Alchemy of Finance" some
> years ago, I was relieved to finally finish the damn thing. I felt
> like I had been wandering in the jungle and my machete arm was just
> about to give out on me. I don't know if it's because Soros is a
> lousy writer, or if the thought problems he likes to discuss are
> simply difficult to describe, or both.
>
> The post's author may be interested in going straight to the source:
> Sir Karl Popper. His book "Conjectures and Refutations" is an excellent
> way to get a feel for what shaped Soros' thinking the most. It's
> a great book, broken into fairly digestible chapters, and skillfully
> written.
> thanks for the review - I also read (or tried to read) “The Crash
> of 2008 and What it Means”
>
> you are correct. the books is painfully difficult to read;
>
> I would pass on Soros book - it is at the bottom of the list of investment
> books to read
> This is a guy I have never understood why people hate. he takes his
> position, makes it public and explains why. rogers, Buffett, Soros,
> einhorn,shiff, Faber. along with others. they have been successful
> over many years doing their own thing and bucking tradition.
> As I recall, Soros's Theory of Reflexivity pre-dates this book. I
> recall him outlining it in the late 90's.
Most people either don't have the intellectual brainpower to grasp such an idea or prefer not to work hard enough to uncover truths such a this and so they remain one of the sheeple who get fleeced on a regular basis by the powers that be.
In dealing with such a "complex" theory, IMO, it is important to have a grasp of the real factors that control group thinking. I would start with understanding the two basic motivators: fear and greed. Learn to step outside of your own fear and greed and you will learn how to profit and even be a means of support for a system in panic. What? Only those who were able to see opportunity in the panic on October 10th, 2008, kept the entire stock market from crashing to a point of no return.
Read about "The Fourth Turning" and "Generational Dynamics" and understand demographics PRIOR to making investment decisions and you will have a HUGE advantage over the typical investor who plays hunches and follows the crowd.
Finally, to be a succesful investor, don't get caught up in specific data points too much and don't be married to a position of bearishness or bullishness without regards to the facts. As an investor, if you are going to be married to something, marry the truth.
> It is very clear to me that the US real estate bubble was caused
> by political intervention in congress. Had government oversight legislation
> of Fannie and Freddie gotten through congress in 2003, at least 80%
> of this disaster never happens. Isn't the problem really just the
> imperfrections and bias of the mainstream media in >disseminating credible information.
The real foundation of the crisis we are facing is a matter of generational dynamics. It has been so long since we have seen a real recession or depression or had to wonder how we were going to keep a roof over our heads or put food on the table that we truly came to believe that it could not happen again. We truly came to believe that we could endlessly flip houses and make money. We came to believe that w were geniuses who were masters of the universe, or at least the stock market.
In short, it was our own ego, greed and stupidity that set us up for this fall. We have no one to blame but ourslevles and those who insist on only placing the blame on someone else are doomed to continue repeating the mistakes they have made.
present value perpetuity of the stream of rent income is $1,680,000.”
Why I agree with your conclusion, your first word explains exactly why “irrationality “ is at the base of bubble building.
It all hinges on the “IF” part. The irrational behavior is in believing such nonsense (as interest rates will stay at 1%).
The “fair” value analysis only applies in a theoretical vacuum or in an “irrational” bubble, as the main ingredient has to be the belief part.
IF the market can believe that “long-run” interest rates will be 1% the market also believe that prices will only go up for the “long-run”. Thus they behave “irrationally”.
On Jul 12 11:11 PM Arthur Hau wrote:
> I don't know why people still think that a bubble is necessarily
> built by people's irrationality or some sort of disequilibrium in
> the financial market.
>
> When you have a prolonged period of low interest rate, the so-called
> real estate market bubble (similarly stock market bubble) is actually
> RATIONAL!
>
> Suppose you have an apartment that can be rented out at $1,400 a
> month and hence $16,800 a year.
>
> If the market believes that the long-run interest rate is 1%, the
> present value perpetuity of the stream of rent income is $1,680,000.
> That is the apartment's "fair" value is about $1,680,000.
>
> If the market believes that the long-run interest rate is 5%, the
> present value perpetuity of the same stream of rent income is worth
> only $336,000. That is the apartment's "fair" value is only about
> $336,000.
>
> If the Fed keeps the interest rate low for a long while, any so-called
> bubble is only the result of rational computation from some FIN 101
> theory in finance.
>
> Mr. Greenspan correctly contained the internet bubble by flushing
> the stock market with liquidity and low interest rate. However, he
> did not have any exit plan. The right time for raising the interest
> rate steadily back from 1% to 5% should have been the period of 2003-2006.
> Instead, it waited until Dr. Bernanke finally realized that there
> was a possible bubble. Bernanke tried to correct the bubble by raising
> the interest rate, but It was already too late!
>
> The U.S. should have a minor bubble burst in 2006, instead of a major
> bubble burst in 2008. Thanks to Mr. Greenspan, a small financial
> crisis had turned into a financial tsunami.
>
> Now, the interest rate is back to historical low. Is there an exit
> plan? The real estate prices in NYC was down but not by a sufficient
> amount. What will happen when the interest rate rises again?
>
> Monetary policy can only contain a bubble, not correct it. You want
> the bust to go away? You better improve the productivity of the economy.
> Promoting speculative activity by lowering interest rate further
> won't work!
what more proof you need?
On Jul 10 06:35 PM whidbey wrote:
> Reflexivity strikes most classical economist as unnecessary for most
> of the reasons Soros seems to find it so appropriate.
>
> The lack of an equilibrium shocks no one presumably. The markets
> are working towards equilibration in the short run but may never
> reach the objective. As for his explanation of how disequilibrium
> can lead to bubbles, he has not offered any data to support his claims
> of its explanatory or descriptive powers. As theory goes his work
> is best classified as descriptive, but not predictive in any sense.
> In short, he is not likely to receive a Nobel prize for his thinking.
> His risking is something else and worth some further research possibly.