The New Paradigm for Financial Markets: The Credit Crisis and What It Means, George Soros, Public Affairs, New York, 2008

This work is Soros’ latest contribution to assessing the problems with and prospects for the financial system. The book focuses on the recent credit crisis, its causes and what will be required to prevent further dramatic strains on the markets and the financial system in general. As the title suggests, Soros calls for a substantial rethinking of how markets and financial institutions work. Soros criticizes the current orthodoxy in economic thinking and adherence to equilibrium theory and its component parts such as perfect knowledge/information and rational expectations. For Soros, our understanding of markets and financial systems will only be improved with a better theoretical framework which, according to Soros, is the theory of reflexivity. As Soros describes it, the theory of reflexivity is an acknowledgement of the objective facts of a situation and how those facts interact with a person’s subjective understanding of them leading to highly unpredictable outcomes. Soros uses the current credit crisis as an example of how markets can be better explained by a theory of reflexivity rather than by equilibrium theory.

Soros uses his own experiences as a speculator to trace the ongoing credit crisis and housing bubble and describes his reactions to them as an investor and trader. Among other observations, Soros concludes that the era of easy credit is gone, at least for a long time. Soros also offers some macroeconomic outlooks for 2008 which he incorporates into a mini-diary; outlooks which have been informed by the credit crisis as it has unfolded over the last months.

Trying to offer any type of economic prediction is always a mug’s game. Soros stresses that he is not offering predictions particularly since the current financial drama is still unfolding and is very fluid. But Soros does offer analysis of the problems as he sees them and some policy recommendations for how to respond. Among these recommendations Soros suggests that increased regulation will be necessary to reign in the current and past excesses of credit markets. Soros blames current excesses in the financial markets on the failure of regulators to exercise proper control. Soros cautions about overdoing regulation, however, since overregulation can impede economic activity. Soros also recommends the establishment of a clearing house or exchange for credit default swaps. As for the mortgage crisis and housing market, Soros supports, in principle, the proposals being advocated by US House Representative Barney Frank.

This book is a useful contribution to the fluid debates about what to do about financial markets and comes from a very savvy and engaged market participant. Soros provides a useful theoretical foundation for his prognostications rather than a purely atheoretical description of events. Despite the fact that the book is light on policy analysis, policy prescription is not the book’s its main purpose. Instead, Soros analyses the current problems in financial markets and articulates an alternate way of thinking about the current ailments. His comments on policy are invitations for further discussion. Even if the size and purpose of the book dictate that the arguments are necessarily general and somewhat superficial, it is a useful call for a new paradigm for financial markets and for a more detailed examination of the perils of easy credit.