Reviewed by David M. Kinchen
In a slim book, with an Introduction and 27 essays, George Soros analyzes the financial meltdown of 2008 in “Financial Turmoil in Europe and the United States” (PublicAffairs Books, 208 pages, index, $19.99). The 81-year old Hungarian born billionaire investor and philanthropist not only gives his expert opinion on what went wrong, he offers concrete solutions to prevent another crisis that rivaled the Great Depression of the 1930s — a crisis that continues to roil the world.
Most of the essays originally appeared in Financial Times, the widely respected British and international financial newspaper that many consider to be superior to The Wall Street Journal — especially to those leery of Rupert Murdoch’s ownership of the latter. Others appeared in the liberal publication The New York Review of Books.
Don’t skip the comprehensive introduction: Soros traces the roots of the meltdown to policies initiated in the early 1980s by the Reagan administration, especially financial deregulation and supply-side economics that asserts that the markets are self correcting, that they follow rules similar to that of Newtonian physics. Not so, says Soros, who knows the market from the inside out (sometimes more inside than the laws permit, as his controversial conviction for insider trading by the French stock exchange regulatory agency in 2005 — after a delay of 14 years after the alleged events — shows.
I was disappointed that Soros didn’t discuss the financial deregulation under the Democratic administration of Bill Clinton, other than mentioning that the scrapping of the Glass-Steagall act in 1999 is an event that most likely cannot be reversed. This Great Depression era legislation created the Federal Deposit Insurance Corporation (FDIC) and separated commercial and investment banks. On Page 50 Soros writes in the essay “The Three Steps to Financial Reform” (Financial Times, June 10, 2009) that “It is probably impractical to separate investment banking from commercial banking as the US did with the Glass-Steagall Act of 1933. But there has to be an internal firewall that separates proprietary trading from commercial banking. Proprietary trading ought to be financed out of a bank’s own capital.”
Conservatives — most of whom hate Soros and his ideas — will rankle at a passage immediately following this: “They [financial regulators] must regulate the compensation packages of proprietary traders so that the risks and rewards are properly aligned. This may push proprietary trading out of banks into hedge funds. That is where it properly belongs. Hedge funds and other large investors must also be closely monitored to ensure that they do not build up dangerous inbalances.”
On Page 55, Soros again addresses Glass-Steagall, which I — along with many respected economists — believe was instrumental in preventing bubbles from turning into meltdowns like that of 2008. I don’t see any reason why the Gramm-Leach-Bliley legislation that replaced Glass-Steagall can’t be modified to separate commercial and investment banks. Soros says on that page, “…there have to be internal compartments that separate proprietary trading from commercial banking and seal off trading in various markets to reduce contagion.” Yes, but the best way to do this, in my opinion, and especially of those of many economists, is to separate commercial and investment banking — as Glass-Steagall specifically and almost always effectively did.
To show the clarity of Soros’ writing, I’m reprinting — from the PublicAffairs Books website — an excerpt from the book:
“The euro crisis is a direct consequence of the crash of 2008. When Lehman Brothers failed, the entire financial system started to collapse and had to be put on artificial life support. This took the form of substituting the sovereign credit of governments for the bank and other credit that had collapsed. At a memorable meeting of European finance ministers in November 2008, they guaranteed that no other financial institutions that are important to the workings of the financial system would be allowed to fail, and their example was followed by the United States.
“Angela Merkel [Germany’s chancellor] then declared that the guarantee should be exercised by each European state individually, not by the European Union or the eurozone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury. The crisis itself erupted more than a year later, in 2010.
“There is some similarity between the euro crisis and the subprime crisis that caused the crash of 2008. In each case a supposedly riskless asset—collateralized debt obligations (CDOs), based largely on mortgages, in 2008, and European government bonds now—lost some or all of their value.
“Unfortunately the euro crisis is more intractable. In 2008 the US financial authorities that were needed to respond to the crisis were in place; at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe. The political will to create a common European treasury was absent in the first place; and since the time when the euro was created the political cohesion of the European Union has greatly deteriorated. As a result there is no clearly visible solution to the euro crisis. In its absence the authorities have been trying to buy time.”
You don’t have to be an economist to understand the essays, they’re written in astoundingly clear prose. I did notice, in the Introduction, on page ix, that one of the publisher’s copyeditors missed correcting the spelling of “strait jacket”, which Soros writes as “straight jacket.” (To be totally fair to the editors, at least one of my dictionaries–“Webster’s II New Riverside University Dictionary” — gives “straight jacket” as an alternative spelling, but the preferred one is “strait jacket.”).
Since they were published in newspapers and other periodicals, the essays are real-time analyses of the events of the crash of 2008, from those days in September 2008 when everything seemed to be tumbling down to the end of 2011 when the financial meltdown of the small Eurozone country of Greece and the perilous positions of other European countries.
While many — if not most — of the essays deal with the problems with the euro, which Soros says is flawed because the European Union currency adopted in 1999 has a central bank but no central treasury, Soros addresses the urgent need for the U.S. to restructure its banking and financial system. He anticipates the globalization of the crisis and, in particular, its perilous second phase in Europe; and finally he calls for concerted international action.
While charting the journey from the American mortgage crisis to riots in Athens, Soros often reveals an alternate course to that chosen by the U.S. and European governments. Soros was among the first to appreciate the scale of the disruption, and that “these are not normal times.” His analysis is cogent, informed by years as a fund manager and supporter of European integration. His concern for the eurozone’s future is palpable, as the markets test Europe’s banks and political processes to the brink of destruction, to a degree never before seen—or foreseen—since the creation of the European Community.
As a journalist who has spent much of his career covering real estate, I was particularly drawn to the essay (Pages 63-68) “Reforming a Broken Mortgage System” wherein Soros addresses the problems of Fannie Mae and Freddie Mac, “the government-sponsored enterprises (GSEs) now in limbo.” I couldn’t agree more when Soros says the business model of the two GSEs is “fundamentally unsound. These public-private partnerships are supposed to serve the public interest as well as the interest of shareholders.” What needs to be done, Soros writes on Page 65, is that Fannie’s and Freddie’s mortgage insurance function “must be separated from the mortgage financing. The former, mortgage insurance, is the legitimate function of a government agency — especially when the private sector has collapsed. It should be run as a government agency.” The folks at MGIC and other private mortgage insurers might beg to disagree, but Soros has a point here, and he adds that “mortgage financing should revert to the private sector. This would get rid of a business model that has failed.”
The Danes have a system that has worked well since the Great Fire of Copenhagen in 1795, Soros writes (Page 65). The Danish model has not prevented housing bubbles (in fact I read of a recent one in the tiny country) but “it has never broken down. And it proved its worth again in 2008.”
In a piece I found on a Google search, Soros describes in considerable detail the Danish system that he discusses briefly in the book:
“It remains the best performing in Europe during the current crisis. First, it is an open system in which all mortgage originators can participate on equal terms as long as they meet the rigorous regulatory requirements. There are no GSEs enjoying a quasimonopolistic position.
“Second, mortgage originators are required to retain credit risk and to perform the servicing functions, thereby properly aligning the incentives. Third, the mortgage is funded by the issuance of standardized bonds, creating a large and liquid market. Indeed, the spread on Danish mortgage bonds is similar to the option-adjusted spread on bonds issued by the GSEs, although they carry no implicit government guarantees.
“Finally, the asymmetric nature of American mortgages is replaced by what the Danes call the Principle of Balance. Every mortgage is instantly converted into a security of the same amount and the two remain interchangeable at all times. Homeowners can retire mortgages not only by paying them off, but also by buying an equivalent face amount of bonds at market price. Because the value of homes and the associated mortgage bonds tend to move in the same direction, homeowners should not end up with negative equity in their homes. To state it more clearly, as home prices decline, the amount that a homeowner must spend to retire his mortgage decreases because he can buy the bonds at lower prices.
“The U.S. can emulate the Danish system with surprisingly few modifications from our current practices. What is required is transparent, standardized securities which create large and fungible pools. Today in the U.S., over half of all mortgages are securitized by Ginnie Mae, which issues standardized securities. All that is missing is allowing the borrowers to redeem their mortgages at the lower of par or market.
“Because of the current havoc in the mortgage market, there is no confidence in the origination and securitization process. As a result, a government guarantee is indispensable at this time, and may be needed for the next few years. As the private sector regains its strength, the government guarantees could, and should, be gradually phased out.
“How to get there from here? It will involve modifying the existing stock of mortgages, so that the principal does not exceed the current market value of the houses, and refinancing them with Danish-style loans. The modification will have to be done by servicing companies that need to be properly incentivized. Modifying mortgages that have been sliced and diced into securitizations may require legislative authorization. The virtual monopoly of the GSEs would be terminated and they would be liquidated over time.”
This makes sense to me! Let’s get rid of Fannie and Freddie or sell them off to Soros or The Blackstone Group or Bain Capital or KKR, or anybody who wants to buy them! We already have enough government agencies dealing with housing, which in my “cafeteria libertarian” philosophy the federal government shouldn’t be involved in the first place. Housing should be a local — or statewide at best — concern and the obsession of both political parties with trying to make everybody a homeowner is what got us into the current mess in the first place, in my opinion.
Although I disagree with Soros on many political issues, I found the essays in this book, especially the above cited essay on restructuring the U.S. mortgage system, profoundly reasonable. The book is worth reading by those of all political persuasions, and especially by legislators struggling with the current flawed financial infrastructure that affects all nations in this era of globalization.
About the author
George Soros is chairman of Soros Fund Management and is the founder of a global network of foundations dedicated to supporting open societies. He is the author of several best-selling books includingThe Crash of 2008: The New Paradigm for Financial Markets; The Crisis of Global Capitalism, The Bubble of American Supremacy, Underwriting Democracy, and The Age of Fallibility. He was born in Budapest in 1930 and lives in New York City.
Publisher’s website: www.publicaffairsbooks.com