>>Western governors don't trust FERC.>> Who could blame 'em Quincy ? Soros wouldn't either -- here's his essay that's making the usual SI rounds. It rather puts lie to the nonsense that Cheney, Bush and their great good friends Lay, Skilling, and company spewed out regularly.
A good essay, but I always find these a little strange coming from a guy who's had little problem taking advantage of the same.
thenewrepublic.com
WHY THE MARKETS CAN'T FIX THEMSELVES.
Busted
by George Soros
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The whole country is up in arms about corporate abuse and financial
wrongdoing. Our outrage is coupled with amazement: How could it have
happened? Yet we shouldn't be amazed. The excesses of the 1990s boom
and the clamor for reform that has accompanied the current bust are in fact a
recurring feature of financial markets. What is truly amazing is that after so
many boom/bust cycles we still do not properly understand how financial
markets operate.
The prevailing wisdom holds that markets tend toward equilibrium--i.e., a
price at which willing buyers and sellers balance each other out. That may be
true of the market in widgets, but it is emphatically not true of financial
markets. In financial markets a balance is difficult to reach because financial
markets do not deal with known quantities; they try to discount a future that
is contingent on how they discount it at present. What happens in financial
markets can affect the economic "fundamentals" that those markets are
supposed to reflect--which is why recent years have produced such a
dramatic and seemingly irrational stock market rise, followed by an equally
dramatic and seemingly irrational fall. Instead of a one-way connection
between supply and demand via market prices, there is a two-way
connection: Market prices can also alter the conditions of supply and
demand in a circular fashion. In my 1987 book The Alchemy of Finance, I
called this two-way connection "reflexivity." And I think it better explains the
current turmoil in financial markets than the more commonly accepted idea
of equilibrium.
Due to this two-way connection, it is impossible to determine where the
equilibrium lies. Participants have to anticipate a future that is not only
unknown but unknowable. The theory of reflexivity does not offer a new
way of determining the outcome; it holds that the outcome is impossible to
determine. For instance, it was predictable that the Internet bubble would
burst, but it was impossible to predict when. There is a decision fork at
every point along the way, and the actual course is determined only as the
decisions are taken. Such a view undermines the scientific pretensions of
economists. Scientific theories are supposed to explain and predict.
Accepting reflexivity requires acknowledging that social science in general
and economics in particular cannot provide scientifically valid predictions.
This is a paradigm shift that has not occurred.
But even if reflexivity cannot yield firm predictions, it does have considerable
explanatory power. First, it explains how the bias prevailing in financial
markets can be either self-reinforcing or self-defeating. To create a bubble,
the prevailing bias must be first self-reinforcing until it becomes unsustainable
and turns self-reinforcing in the opposite direction (and thus self-defeating).
All boom/bust sequences follow this pattern. Second, by recognizing that
financial decisions cannot be based on firm predictions of the outcome,
reflexivity draws attention to the formative role misconceptions play in the
development of boom/bust sequences. In the conglomerate boom of the
1960s, for instance, the misconception was that growth in earnings per share
is equally valuable whether it is achieved by internal growth or acquisitions. I
remember vividly how, after the conglomerate boom's collapse, the
president of Ogden Corporation (to whom I had sold my brother's
engineering business) told me at lunch that the company's earnings were
falling apart because "I have no audience to play to"--with the stock price
down, he could no longer use that stock to acquire companies and thus
magically boost earnings.
We are now in a similar situation. During the recent boom, corporations
used every device at their disposal to boost earnings to satisfy the ever-rising
expectations that sustained ever-rising stock prices. Clever financial
engineers invented ever-new devices--and when they ran out of legitimate
ones, some corporations turned to illegitimate ones. When the market
turned, some of these illegitimate practices were exposed. For instance,
Enron, like many companies, used special purpose entities (SPEs) to keep
debts off its balance sheets. But unlike many other companies, it used its
own stock to guarantee the debt of its SPE. When its stock price fell, the
scheme unraveled and Enron was pushed into bankruptcy, exposing a
number of other financial misdeeds the company had committed. The Enron
bankruptcy reinforced the downtrend in the stock market, which led to
further bankruptcies and news of further corporate and individual misdeeds.
Both this downtrend and the clamor for corrective action gathered
momentum in a self-reinforcing fashion--just as reflexivity envisions.
There is nothing surprising about this course of events. It has happened
many times before. The real surprise is that we are surprised. After all,
many of the practices that are now condemned were carried on quite
openly. Everybody knew that the best companies, such as General Electric
and Microsoft, were massaging the numbers to maintain the appearance of a
steady progression of earnings. Indeed, investors put a premium on
management's ability to do just that. SPEs could be bought off the shelf, and
investment banks maintained structured finance departments to provide
custom-made designs. Tyco's management proudly proclaimed that they
could generate earnings growth by acquiring companies, some of which
could be moved offshore by virtue of Tyco's Bermuda incorporation, and
investors put a high multiple on its earnings. Stock options were not only
accepted but considered a useful device for boosting shareholders' values
since they provided executive compensation without incurring any costs and
encouraged management to focus on the stock price above all other
considerations.
If there is a major difference between today's crisis and, say, the late '60s
conglomerate boom--where investors also rewarded per-share-earnings
growth without regard to how it was achieved--it is a difference of scope.
The conglomerate boom involved only a segment of the stock market--the
conglomerates and the companies they acquired--and a segment of the
investing public, spearheaded by the so-called "go-go" funds. When the
conglomerates began to threaten the overall financial establishment, that
establishment closed ranks against them. By contrast, the '90s boom
encompassed the entire corporate and investment community, and today's
establishment, including today's political establishment, was fully complicit.
Enron, WorldCom, and Arthur Andersen could not have gotten away with
their nefarious activities without encouragement and active reinforcement
from virtually all sectors of American society--their corporate peers,
investment professionals, politicians, the media, and the public at large.
Whereas the conglomerate boom ended because of resistance from the
establishment, in this case the boom was allowed to run its course, and the
search for corrective measures started only after the collapse. Even now, a
pro-business administration is trying to downplay the damage. In looking for
remedies, it is not enough to make an example of a few offenders. We are
all implicated and must all reexamine our view of the world.
According to the theory of reflexivity, misconceptions or flawed ideas are
generally responsible, at least in part, for most boom/bust sequences.
Analyzing what went wrong in the '90s, we can identify two specific
elements: a decline in professional standards and a dramatic rise in conflicts
of interest. And both are really symptoms of the same broader problem: the
glorification of financial gain irrespective of how it is achieved. The
professions--lawyers, accountants, auditors, security analysts, corporate
officers, and bankers--allowed the pursuit of profit to trump longstanding
professional values. Security analysts promoted stocks to gain
investment-banking business; bankers, lawyers, and auditors aided and
abetted deceptive practices for the same reason. Similarly, conflicts of
interest were ignored in the mad dash for profits. While only a small number
of people committed acts that actually qualify as criminal, many more
engaged in activities that in retrospect appear dubious and misleading. They
did so thanks to reassuring legal opinions, Generally Accepted Accounting
Principles (GAAP), and the comforting knowledge that everybody else was
doing the same. When broad principles are minutely codified--as they are in
the GAAP--the rules paradoxically become easier to evade. A whole industry
was born, called structured finance, largely devoted to rule evasion. Once a
financial innovation was successfully introduced it was eagerly imitated, and
the limits of the acceptable were progressively pushed out by aggressive or
unscrupulous practitioners. A process of natural selection was at work:
Those who refused to be swayed were pushed to the sidelines; those leading
the process could not see the danger signs because they were carried away
by their own success and the reinforcement they received from others. As a
source told The Financial Times, "They couldn't see the iceberg because
they were standing on top of it."
Underlying this indiscriminate pursuit of financial success was a belief that the
common interest is best served by allowing people to pursue their narrow
self-interest. In the nineteenth century this was called "laissez-faire," but since
most of its current adherents don't speak French, I have given it a more
contemporary name: market fundamentalism. Market fundamentalism
became dominant around 1980, when Ronald Reagan was elected president
in the United States and shortly after Margaret Thatcher was chosen as
prime minister in the United Kingdom. Its goal was to remove regulation and
other forms of government intervention from the economy and to promote
the free movement of capital and entrepreneurship both domestically and
internationally. The globalization of financial markets was a
market-fundamentalist project, and it made remarkable headway before its
shortcomings were exposed.
Market fundamentalism is a false and dangerous ideology. It is false on at
least two counts. First, it profoundly misapprehends the way financial
markets operate. It assumes that markets tend toward equilibrium and that
equilibrium assures the optimum allocation of resources. Academic
economists have proceeded far beyond general equilibrium--multiple
equilibriums are all the rage now--but market fundamentalists continue to
believe they have solid science behind them, not just economics but also
Charles Darwin's theory of survival of the fittest. Second, by equating
private interests with the public interest, market fundamentalism endows the
pursuit of self-interest with a moral quality.
But if financial markets do not tend toward equilibrium, as the theory of
reflexivity maintains, private interests cannot be equated with the public
interest. Left to their own devices, financial markets are liable to go to
socially disruptive extremes.
Next: "What distinguishes markets is exactly that they are amoral..."
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