Reuters, R. Schiller

George Soros

investor

He entered the investment business in the 1960s and heads Soros Fund Management. He is considered the first American to earn $1 billion in a year: in September 1992, he played against the pound sterling, bringing its rate down from $1.92 to $1.5. Philanthropist, founder of charitable foundations, including the Open Society. Author of the books The Alchemy of Finance, Discovering the Soviet System, The Crisis of World Capitalism, etc.

"It is a mistake to rely on the market's ability to correct itself."

– You often say that markets are not characterized by a desire for equilibrium, but by “reflexivity” – the unconscious behavior of investors, on the contrary, forces markets to deviate from equilibrium. Does the situation on the US housing market fit into this model?

– The reflexivity is explained by the interaction between the value of collateral and the willingness to lend... The higher the willingness to lend, the higher the value of collateral. As a result, annual housing price growth rates can be in the double digits for three or more years in a row. But eventually there is a turning point, the value of collateral starts to decline, which undermines the willingness to lend, which further undermines the value of collateral, and you get a recession.

The same thing happened in the 1980s, when the international banking crisis hit. Brazil had been growing at 8% a year for a decade and could borrow more and more, and it was growing because it could borrow more. Finally [then-Federal Reserve Chairman] Paul Volcker said, "Enough," and the turning point came.

Bubbles begin to inflate when there is a gap between expectations and reality. High expectations lead to improved fundamentals because companies can borrow money more easily, which again fuels expectations. This is where special instruments are created that allow loans to be obtained on increasingly easy terms; this stimulates demand and pushes prices up. A period of acceleration begins – until the gap between expectations and reality becomes insurmountable. People gradually become aware of this gap, but continue to move forward out of inertia. Eventually, reality begins to undermine expectations, and a recession begins.

– But didn’t the housing market start with favorable fundamentals – low interest rates making homes more affordable?

– The Federal Reserve System (Fed) has certainly handled the situation carelessly. The monetary authorities are guided by a theory of the market, which I think is wrong. The idea is that the market reflects reality, so you have to rely on the market. In fact, with all these new instruments, it is incredibly difficult to calculate risk, so in the end they stopped calculating it themselves. There are professionals who work with risks, let's rely on these professionals to control their risks, the authorities decided. This is a fundamental mistake – to rely so much on the ability of the market to correct itself.

The job of policymakers is to keep excesses from developing. [Former Fed Chairman] Alan Greenspan tried to do that, talking about “irrational euphoria” in the stock market. But he was criticized for trying to undermine growth, and he gave up, saying, “Asset price controls are not our job. We’re working to keep inflation from accelerating and to support economic growth.”

You can see reflexivity in the work of rating agencies. They created a lot of confusion; people relied on them too much, financial engineering allowed the risk to be spread [among a large number of market participants], which allowed people to take on more and more risks.

– The United States has not experienced a nationwide housing downturn since the Great Depression. Do you agree that this created an overconfidence in the safety of mortgages, which in turn led to a loosening of lending standards?

– The boom-bust cycle usually starts when there is some kind of glitch in people’s heads, and this is a manifestation of reflexivity. If we go back to the international banking crisis, banks used various ratios as creditworthiness indicators, such as the debt-to-GDP or export ratio, forgetting that their willingness to lend affects these ratios. In this case, the glitch is that housing began to be considered collateral that cannot become cheaper. Consequently, more and more loans can be issued against it. For 100% of the cost of the house, for 105%. And the down payment can be reduced from 30% to zero.

– How can people ignore fundamental factors?

– People in the market work in a competitive environment. Let’s say someone says it’s unreasonable and stops lending. But others will continue to do so. And those who stop lending will simply lose their jobs because they don’t show high results. So everything will continue as long as the music plays. If you stop dancing too early, you will be thrown out of the room.

– When prices get too far removed from fundamentals, people in a bubble start looking for new fundamentals that will justify current prices...

- This is the very failure - people stop adequately assessing the market situation. The fundamental principle of reflexivity is manifested in the fact that financial markets do not gravitate towards equilibrium. But those who believe in equilibrium must find an explanation for why mortgages remain a safe investment, although borrowers' loan payments have increased from 20% to 40% of income, etc.

– Was the Internet bubble of the late 1990s also a manifestation of reflexivity?

- Yes. Since market participants looked at sales growth rates, companies had to continue to demonstrate them, even if the business model turned out to be untenable. Otherwise, it would be impossible for them to maintain capitalization at such an unreasonably high level.

– How severe will the downturn in the housing market be?

– A lot depends on how far the authorities are willing to go. The situation is complicated by the fact that the housing boom is linked to a current account deficit, which in turn is linked to a certain extent to a budget deficit. When the Fed said, “We have a neutral stance on interest rates,” it was because they couldn’t move in either direction, because today there is still a problem with the dollar. Several boom-bust cycles are happening simultaneously, the dollar one is one of them.

Paul Walker

Chairman of the US Federal Reserve from 1979 to 1987.

By pursuing a tight monetary policy, Volcker defeated inflation – it fell from 13.5% in 1981 to 3.2% in 1983 and remained low for another quarter of a century, but provoked a recession in the United States and a crisis among banks – creditors of developing countries. He organized the rescue of large banks that found themselves on the verge of bankruptcy in the 1980s. Later, he headed the board of trustees of the International Accounting Standards Committee and the UN commission investigating violations in the Oil-for-Food program in Iraq.

"Financial institutions have become a source of distribution of dodgy assets"

– Can you compare the current crisis with the banking crisis of the early 1980s?

– We don’t yet know the true scale of this crisis. Many countries were involved in that crisis, which complicated matters from a political and economic point of view. But today, the market opacity and uncertainty about the cost of credit instruments are much higher. In the early 1980s, the size of the debt was known, as were its holders – a relatively small group of banks.

– Securitization was supposed to redistribute risks from banks to capital market participants, making the financial system more stable. Hasn’t it turned out that it actually became less stable?

– The system worked well during small crises; now we have to find out how well it works during big ones. There have been hedge fund collapses, and the crisis has been overcome quite quickly. The risks are spread across the financial system to a much greater extent than in the 1980s, but we don’t yet know how big they are.

– Today banks are much stronger than in the 1980s. Can this be considered a positive factor?

- Absolutely. There is no such threat to the banking system today as there was in 1982. The capital adequacy of banks is much higher; that was a real problem then. But the real problem today is that financial institutions have become a source of proliferation of dodgy assets; their liabilities are also much more difficult to understand and evaluate today.

– Does this pose a serious threat to economic growth?

– We don’t know yet. Consumers were living beyond their means, and they were given loans based on the expectation of rising home values. Now that that door has closed, they are starting to live within their means. Sooner or later, the adjustment was bound to happen. I don’t think the adjustment will necessarily be difficult, but it won’t be smooth either. It never is.

– Was the crisis predictable?

- I think so. It was no secret that there was something like a bubble in the housing market. Many people, including myself, said that the country was spending more than it was producing, and this could not last forever.

William Seidman

Chairman of the Federal Deposit Insurance Corporation From 1985 to 1991, and from 1989 to 1991, he was the first chairman of the Resolution Trust Corporation

In both government agencies, he worked to eliminate the consequences of the savings and loan crisis, which resulted in the bankruptcy of more than 1,000 financial institutions. He served as an economic adviser to Presidents Gerald Ford and Ronald Reagan. He publishes the financial magazine Bank Director, and is the chief commentator on economic issues for CNBC.

"Credit" comes from credo, which means "I believe." If you don't believe, there will be no credit."

– Can the current crisis be compared to the savings and loan crisis?

– They are different. The current one is essentially a crisis in the private sector, and that crisis involved institutions that accepted deposits that were insured by the state. It is not that serious yet. Then several large banks went bankrupt. According to the existing regulations, Bank of America and Citibank were insolvent, but the regulations were adjusted, they received capital. The viability of the system itself was called into question. Today it is not like that; thanks to securitization, part of the losses are borne by financial market participants, not financial institutions.

– But today it turns out that the banks are linked to off-balance sheet funds that invested in high-risk mortgage bonds...

- Right. And everyone is trying to persuade the government to fill the gap created by the corporate bill market ceasing to function. They are trying to involve the Federal Home Loan Banks, Fannie Mae, Freddie Mac. There is a lot of pressure to turn this into something similar to the events of the 1980s. But for now, the crisis is small.

– How might the macroeconomic consequences differ?

– The S&L crisis was initially concentrated in a few states, where it had a huge impact on the economy: Texas, Florida, California, Massachusetts. The current crisis is much broader. The question is whether banks will cut back on loans to such an extent that it will hurt the economy as a whole. This is already happening, but on a small scale so far. The situation is as old as the hills: “credit” comes from the Latin credo, which means “I believe.” If you don’t believe, there will be no credit.

Robert Schiller

Professor of Economics at Yale University

Studies the dependence of asset prices on human psychology. In 2000, he published the book Irrational Euphoria, in which he argued that the stock market boom was driven by psychological rather than fundamental factors. Together with Professor Carl Case, he studies the housing market; they are the authors of the S&P/Case-Shiller Home Price index family, which tracks the dynamics of residential property prices in the United States.

"Owning a home is a responsibility and not everyone can handle it."

– For an American, a house is not just a piece of property, but the embodiment of the American dream. Do you think this helped to create a bubble by creating an emotional attachment to an asset whose value is not based on fundamental factors?

– It is good that our country encourages home ownership. One of the reasons for this is that we have fewer conflicts between ethnic groups than other countries. But perhaps we have gone too far in allowing so many people to become homeowners without any effort; it has become an excuse for extravagant lending practices. Owning a home is a responsibility, and not everyone can bear it; for them, there is renting.

– Does the fact that housing prices rarely fall across the country influence people’s behavior?

– Most people think that housing prices can’t fall for long. They point to the fact that there hasn’t been a major decline since the Great Depression. I think people lack historical perspective – they don’t realize that major events can happen once every 70 years. I was shocked to realize that there is no index tracking the dynamics of housing prices since then. But there is a widespread belief that there hasn’t been a nationwide housing downturn.

I think the stock market boom of the late 1990s gave many people a taste of being investors. In a 2003 survey of recent home buyers, I asked: Did the stock market crash of 2000–2002 make you want to buy a home or did it stop you from buying? Seventy percent said neither, and that I would buy one anyway. Of the remaining 30 percent, 10 times as many said “made you want to buy one.” Their explanations can be summarized as follows: “I’m tired of the stock market. I’ve been promised high returns so many times, but the broker and accountants lied to me. And the house always goes up in value. And I get a lot of satisfaction from owning a house and being able to see it every day.”

Where does the crisis come from?