'The Crash of 2008 and What It Means' by George Soros

Reading - 'The Crash of 2008 and What It Means' by George Soros http://seekingalpha.com/a/36be

Bubbles - Reflexivity & Contamination

“The Crash of 2008 and What it Means”, by George Soros is painfully difficult to read; the concept of reflexivity is not easy to understand; it is abstract and frankly, not very well written. But it has profound implications; it explains an important theory. Equally, it lets you into the mind of a highly successful speculator.

If you take the time to read it, do so not for pleasure. Do so in the quest of knowledge. After plodding through it slowly, and re-reading parts to try and understand what it is all about, I can say I believe I have gained some insight into the world of bubbles and into the marvelous mind of the man I see as the world’s greatest speculator.

First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.

Bubbles thus have two components: a trend that prevails in reality and a misconception relating to that trend. The simplest and most common example is to be found in real estate. The trend consists of an increased willingness to lend and a rise in prices. The misconception is that the value of the real estate is independent of the willingness to lend. That misconception encourages bankers to become more lax in their lending practices as prices rise and defaults on mortgage payments diminish. That is how real estate bubbles, including the recent housing bubble, are born. It is remarkable how the misconception continues to recur in various guises in spite of a long history of real estate bubbles bursting.” - George Soros – The Crisis & What to Do About It.

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