The New Paradigm for Financial Markets

Published in May 2008, the book makes two linked claims. The first is philosophical: markets do not tend toward equilibrium, because participants act on biased views that in turn change the fundamentals they are trying to price. Soros calls this two-way feedback reflexivity. The second is historical: the housing bubble sat on top of a much larger super-bubble built since the 1980s from credit expansion encouraged by repeated bailouts, the globalization of finance, and deregulation combined with fast financial innovation.

Soros writes as the founder of Soros Fund Management and the Quantum Fund, and as a former student of Karl Popper at the London School of Economics. It is candid about his ambitions as a philosopher. He blames what he calls market fundamentalism, the belief that markets correct themselves.

The book's value today is that it was written before the outcome was known. Soros called the episode the worst financial crisis since the 1930s while markets were still shrugging off large bank losses. Reviewers noted the limits. Richard Vague argued that the mortgage buildup was plain in public data and that the book ignores demographics, and C. P. Chandrasekhar found the policy chapter a set of partial measures that never says where the line between state and market should sit.

Read it for the reflexivity framework and for a contemporaneous view of 2008. Readers who want the full theory should pair it with The Alchemy of Finance.

1. Markets are not self-correcting. Soros argues that participants' biased expectations change the fundamentals, so prices can move further from reality for longer than equilibrium models allow.
2. Lending changes the value of collateral. Easy credit pushes up house prices, higher prices justify more lending, and the loop runs in reverse when credit tightens.
3. Look for the bigger bubble underneath. The subprime collapse was a trigger; the real exposure was decades of rising leverage across households, firms and the financial system.
4. Bailouts build moral hazard. Each rescue since the 1980s encouraged more credit expansion, which Soros sees as a central driver of the super-bubble.
5. Policy should watch asset prices and leverage. He argues central banks should lean against credit-fueled booms, not only against consumer-price inflation.

The book is short and moves from theory to the crisis to Soros's own market calls.

1. Setting the stage. Soros describes the turmoil that began in August 2007 and argues it marks the end of an era of credit expansion, not a routine correction.
2. The core idea. In a chapter titled Autobiography of a Failed Philosopher, he explains how his Popper-influenced thinking about fallibility led to the theory of reflexivity, then sets out the theory and how it applies to financial markets, using the feedback loop between lending and collateral values as his main example.
3. The super-bubble hypothesis. He separates the housing bubble from a longer super-bubble driven by credit growth, financial globalization and deregulation, all underwritten by faith in self-correcting markets.
4. Autobiography of a successful speculator. Soros explains how he has used reflexivity in his own trading, looking for gaps between perception and reality that will eventually close.
5. Outlook and policy. He gives his outlook for 2008, including a weaker dollar and US economy and the rise of China, India and oil producers, and ends with recommendations: monetary authorities should target asset bubbles as well as consumer prices, regulators should control credit and leverage, and the state should help homeowners facing foreclosure.

In the midst of the most serious financial upheaval since the Great Depression, legendary financier George Soros explores the origins of the crisis and its implications for the future. Soros, whose breadth of experience in financial markets is unrivaled, places the current crisis in the context of decades of study of how individuals and institutions handle the boom and bust cycles that now dominate global economic activity. This is the worst financial crisis since the 1930s,” writes Soros in characterizing the scale of financial distress spreading across Wall Street and other financial centers around the world. In a concise essay that combines practical insight with philosophical depth, Soros makes an invaluable contribution to our understanding of the great credit crisis and its implications for our nation and the world.