:00:03. > :00:08.who has an exclusive interview with billionaire financier, Gorge Soros.
:00:08. > :00:11.1234 three years ago, governments had to step in to save the banks.
:00:12. > :00:15.Now they're battling to save the euro. In a crucial week for the
:00:15. > :00:20.single European currency, I'm asking my guests, who deserves most
:00:20. > :00:23.blame for this financial mess we're all in? The bankers? Or should we
:00:23. > :00:27.save some time for the economists and who better to answer that
:00:27. > :00:32.question than the billionaire investor George Soros, who thinks
:00:32. > :00:36.all of us, bankers, eeconomists and governments need to go back to
:00:36. > :00:38.square one. We're filming this special series of BBC Radio four
:00:38. > :00:43.programmes about the global economy, so you can seat discussion as well
:00:43. > :00:53.as hear it. -- see the discussion as well as
:00:53. > :00:55.
:00:55. > :01:00.hear it. With me to discuss all this today
:01:00. > :01:04.are George Soros, the billionaire financier turned activist, Sir
:01:04. > :01:07.Howard Davies, who's previously been the director of the London
:01:07. > :01:10.School of Economics and the deputy Governor of the Bank of England and
:01:10. > :01:13.the economist Dr DeAnne Julius, chairman of the think-tank Chatham
:01:14. > :01:17.House and a former member of the Bank of England's Monetary Policy
:01:17. > :01:21.Committee. This mess we're in, let's talk about it and who's to
:01:21. > :01:25.blame for it. I want to get to lessons and solutions later. First,
:01:25. > :01:29.I want a better sense of the root causes. I have a funny feeling
:01:29. > :01:33.there's more to this than just the greed of bankers. George Soros, I
:01:33. > :01:38.must start with you. Was it the bankers and traders who brought on
:01:38. > :01:44.this mess, this crisis? Or the eknomists teachers who told them to
:01:44. > :01:52.put all their faith in markets? bankers and traders are running the
:01:52. > :01:57.markets and the institutions, but the rules by which they play are
:01:57. > :02:03.set by the authorities and the thinking of the authorities is very
:02:03. > :02:08.much influenced by the economic theory. And I think there is
:02:08. > :02:13.something fundamentally wrong with the economic theory that has been
:02:13. > :02:21.guiding us all these years. What, briefly, what do you think was the
:02:21. > :02:26.heart of that problem? Basically, economics tries to be a natural
:02:26. > :02:31.science, but there's a difference between natural science and social
:02:31. > :02:35.science. Because in social science, you're dealing with people who act
:02:35. > :02:44.on the basis of imperfect understanding. The whole economic
:02:44. > :02:48.theory is somehow trying to create an artificial world where this
:02:48. > :02:52.imperfections don't come into play. Dr DeAnne Julius you're an
:02:52. > :02:55.economist, I don't know, should I ask you to stand up for the
:02:55. > :03:00.economists. Did they trap us in a false universe and this is the
:03:00. > :03:03.result? I think the criticism is probably more appropriate to some
:03:03. > :03:07.American economists than European ones. But having said that, I don't
:03:07. > :03:11.think I would put the bulk of the blame for this global financial
:03:11. > :03:17.crisis on the economists. For one thing, economists aren't that
:03:17. > :03:22.powerful. And for another thing, it was such a systemic crisis that
:03:22. > :03:27.mistakes made by many, many actors affected each other and it was
:03:27. > :03:32.intermingled. We have to look at governments, at regulators, at the
:03:32. > :03:36.credit rating agencies, at the boards of some of the major banks
:03:36. > :03:40.and at economists, indeed, and the bankers. Sir Howard Davies, we
:03:40. > :03:45.probably should have started with you. You have written a book called
:03:45. > :03:48.the Financial Crisis - who's to blame. A quick summary? I had 38
:03:48. > :03:51.different answers in the book. Perhaps it's helpful if I spend a
:03:51. > :03:55.couple of minutes on each of them. LAUGHTER
:03:55. > :03:59.. One way of thinking about it is to think about this terrible car
:03:59. > :04:02.crash which we had and to think about the distinction between,
:04:02. > :04:05.that's were, the climatic conditions and the way in which
:04:05. > :04:12.people drove. The climatic conditions,, if you like,, where we
:04:12. > :04:16.had global imbalances, we had a large excess of liquidity, assets
:04:16. > :04:21.coming from China in particular, looking for financial home,, if you
:04:21. > :04:25.like, for safe assets, yielding more than US treshries. We had
:04:25. > :04:30.loose liquidity conditions. We had monetary policy, that at crucial
:04:30. > :04:33.times was too weak, particularly in the US, too loose. But so you had a
:04:33. > :04:37.difficult environment in which it was easy to make mistakes. It was
:04:37. > :04:41.foggy. There was all kind of wind. And within that, financial
:04:41. > :04:45.institutions drove extremely badly. You know, they thought this was
:04:45. > :04:50.fine, that these conditions would carry on. They took on increased
:04:50. > :04:55.debt and borrowing. They created fancy instruments which exploited
:04:55. > :04:58.these conditions to an exaggerated degree. Then, when the climatic
:04:58. > :05:02.conditions suddenly changed and monetary policy started to be
:05:02. > :05:06.tightened and house prices in the US started to flatten off, suddenly,
:05:06. > :05:12.we discovered that we had a horrible house of cards, which then
:05:12. > :05:16.collapsed. I do agree, however w, George, that there was, in the mind
:05:16. > :05:20.set of the authorities, a what now seems touching belief that market
:05:20. > :05:24.prices were fair, that you shouldn't, as the regulators
:05:24. > :05:29.challenge what was going on in the markets, and if people were trading
:05:29. > :05:33.at crazy prices for subprime assets, who were the regulators to
:05:33. > :05:38.challenge that. I do believe that the economics profession influenced
:05:38. > :05:45.the way in which the regulators and the financial authorities worked.
:05:45. > :05:49.To put it simply. You have this concept of equilibrium in economics.
:05:50. > :05:56.That has very little to do with financial markets. Financial
:05:56. > :06:01.markets are rarely in equilibrium. It's assumed that they tend towards
:06:01. > :06:11.eek wi Librium. That's true half the time. At other times they move
:06:11. > :06:15.
:06:15. > :06:22.away from echoey Librium. So this idea that actually people per suing
:06:22. > :06:28.their self-interest, actually result in the best allocation of
:06:28. > :06:31.resources is, in my opinion, a false conception. But if the
:06:31. > :06:35.regulators had come to you during this period, when you were doing
:06:35. > :06:37.very well in your reading of the markets and said, actually, we
:06:37. > :06:41.think these things are getting out of hand. We don't trust you. We
:06:41. > :06:46.don't think you should get involved in these unstruments, what would
:06:46. > :06:52.your response have been? Most of these regulators were scared of
:06:52. > :06:59.saying that. That's right. And I saw it. I was not the only one who
:06:59. > :07:04.saw it. It was clear that this is going to lead it a bad end. I
:07:05. > :07:14.didn't, of course, get it right in the sense that I thought it would
:07:15. > :07:15.
:07:15. > :07:19.collapse much sooner. If I could predict correctly the course of
:07:19. > :07:26.eseents, I would be falsifying my own -- events, I would be
:07:26. > :07:32.falsifying my own theory. So nobody is perfect. This is the whole point
:07:32. > :07:38.that lack of understanding, misunderstandings, false dogmas
:07:38. > :07:41.play a very important role in shaping the course of events.
:07:41. > :07:44.that's a very hard lesson for governments to hear, because they
:07:44. > :07:48.like to think that they can influence the world. But they also
:07:48. > :07:52.want to think that there are rules and there are levers that they can
:07:52. > :07:57.pull. Is this something that we're only just beginning to get to grips
:07:57. > :08:01.with? I certainly agree with George that no-one can really foresee the
:08:01. > :08:05.future or know exactly how things will work out. That's why there
:08:05. > :08:08.needs to be quite an important learning by doing, as it were,
:08:08. > :08:12.rather than for example, at the Bank of England and other central
:08:12. > :08:17.banks, putting too much faith in a forecast and inflation forecast,
:08:17. > :08:23.which I think has not served them very well over this peer yofd time.
:08:23. > :08:26.Indeed, the MoD els that the banks use or at least the Bank of England
:08:27. > :08:30.was using when I was there, didn't even have a financial sector. It
:08:30. > :08:35.was not very helpful in looking at the effects of a financial crisis.
:08:35. > :08:38.It's true that individuals in the marketplace have their own
:08:38. > :08:43.incentives, their own vested interests as it were. Governments
:08:43. > :08:47.of the day, the British Government got a quarter of its tax revenues
:08:47. > :08:50.from the financial sector. So while the financial sector was doing very
:08:50. > :08:55.well, it was not really in the interest of the politicians or the
:08:55. > :08:59.Treasury at the time to rein it back. Economists and others who
:08:59. > :09:04.work in financial institutions have bonuses related to their own profit
:09:04. > :09:08.pools. So taking additional risk means that they benefit from that.
:09:08. > :09:13.Howard, a lot of this comes down to where our economy can go in the
:09:13. > :09:18.next few years. I mean, if all of these aspects of the environment
:09:18. > :09:22.are now, would go -- working against growth and against the kind
:09:22. > :09:27.of recovery that people are used to, have we got our heads round that?
:09:27. > :09:31.What we're living through at the moment is an unpleasant hangover
:09:31. > :09:36.period after this crisis. One of the most insightful books by
:09:36. > :09:39.economists about the crisis has been a book called This Time is
:09:40. > :09:45.Different, where they look at the different financial crises over the
:09:45. > :09:49.last century or so and they tend to reach the conclusion that crises
:09:49. > :09:54.which begin in the financial sector, with the kind of overleverage and
:09:54. > :09:58.excessive debt that we had, take a lot longer to work off than crises
:09:58. > :10:01.that begin in the real economy, when there's perhaps an excess of
:10:01. > :10:05.enthusiasm and optimism and there's a business cycle. This time we have
:10:05. > :10:10.the mother and father of all hangovers with a huge amount of
:10:10. > :10:17.debt. That debt has migrated to some extent in that governments
:10:17. > :10:20.responded to the crisis mark one,, if you like, by doing the rational
:10:20. > :10:24.think by allowing their fiscal position to deteriorate, to offset
:10:24. > :10:28.the private sector recession. Now all that's meant is that the debt
:10:28. > :10:31.has sort of bounced from the private sector into the public
:10:31. > :10:35.sector. The governments have now got an excess of debt.
:10:35. > :10:38.Unfortunately that has got to be worked off in some way. Now we can
:10:38. > :10:42.all argue and perhaps we'll come onto, about precisely the balance
:10:42. > :10:47.of policies that you need in this environment, but I honestly think
:10:47. > :10:51.that anyone who thinks that you can get out of this without more pain
:10:51. > :10:55.and grief is telling fairy stories. The question is just, how do you
:10:55. > :11:00.balance the monetary and fiscal policies to minimise the pain of
:11:00. > :11:04.this adjustment process? Some would say mention of fairy stories brings
:11:04. > :11:08.us neatly to the euro crisis. I want to think about the failures
:11:08. > :11:15.involved there and politicians and economists have been a role in that
:11:15. > :11:20.crisis. George? Let's take something very simple, credit.
:11:20. > :11:30.What's wrong with credit? There is something actually wrong with
:11:30. > :11:31.
:11:31. > :11:39.credit, because you lend against collateral. Right? You give people
:11:39. > :11:43.loans an they want security. Now, you assume that the security is
:11:43. > :11:49.actually safe, that it's always -- it always has the same value, but
:11:49. > :11:57.it doesn't, because the value, let's say of a house, depends on
:11:57. > :12:02.the willingness of the banks to lend. If you have easy monetary
:12:02. > :12:09.conditions, and you can get a loan easily, then the value of the
:12:09. > :12:15.houses goes up. Then you can borrow against that more, right, because
:12:15. > :12:20.and in fact, you, in America, you developed all these fancy
:12:20. > :12:28.instruments where you could take a profit from the improvement in the
:12:28. > :12:38.value of the houses and it was that seeming profit that fuelled the
:12:38. > :12:44.boom. So when you have credit involved, you have the makings of a
:12:44. > :12:49.self-reinforcing process, where the value of the collateral goes up
:12:49. > :12:57.with your willingness to lend, which then increases the amount of
:12:57. > :13:01.credit and it feeds on itself until it becomes unsustainable. Then, you
:13:01. > :13:04.eventually have a process going the other way. What's interesting about
:13:04. > :13:08.the last few years, is that was a private sector problem initially.
:13:08. > :13:12.It was home owners in the US who had that problem. Then in a sense,
:13:12. > :13:17.the solution to that part of the crisis was for all the debt to go
:13:17. > :13:20.onto the government balance sheets. Now in the eurozone, you see the
:13:20. > :13:24.same process playing out with questions about whether the
:13:24. > :13:28.Italians are good for the money that's been lent to them. I mean,
:13:28. > :13:32.this has been a real problem for the Europeans to deal with because
:13:32. > :13:36.of the nature of the structure of the eurozone. Do economists bear
:13:36. > :13:41.some responsibility for not talking louder when the eurozone began and
:13:41. > :13:43.saying, look, this is not going to work? With hindsight I suspect a
:13:43. > :13:48.lot of these problems were certainly discussed at that time.
:13:48. > :13:53.The view was, well, let's get on with it. Let's create the single
:13:53. > :13:57.currency. Let's have the growth and Stability Pact. Let's put
:13:57. > :14:03.constraints on the members' fiscal deficits, as they did. 3% deficit
:14:03. > :14:05.was supposed to be the limit. They did put in place certain targets or
:14:05. > :14:09.constraints, but when you're dealing with sovereign countries,
:14:09. > :14:13.you can't actually do much minister than that. Indeed in the early
:14:13. > :14:16.years, most the countries did behave pretty well. Perhaps because
:14:17. > :14:21.the external conditions were more favourable then. It was only when
:14:21. > :14:26.countries began to take advantage of that situation or to be more
:14:26. > :14:30.charitable to fail to take the step that's they needed to to keep their
:14:30. > :14:34.competitiveness up now they were in a single currency, that things
:14:34. > :14:39.began to get out of hand. Then hit with the global financial crisis,
:14:39. > :14:48.things got rapidly very much out of hand. I think it was a, it was
:14:48. > :14:52.circumstances as much as flaws in It is tough to blame economists for
:14:53. > :14:57.the eurozone. I think actually the centre of gravity of economic
:14:57. > :15:02.thinking about the eurozone when it was constructed was this was not an
:15:02. > :15:06.optimal currency union. But also, that a currency union of this kind
:15:06. > :15:13.needed some kind of fiscal backing. The European Commission's
:15:14. > :15:19.economists proposed in the early days a central budget of 2-3% of
:15:19. > :15:23.European GDP which could be used when one country faced particular
:15:23. > :15:29.difficult economic circumstances so I think economists mainly pointed
:15:29. > :15:35.to the flaws in this design... were too powerful in the face of
:15:35. > :15:38.the financial crisis and not powerful enough in... They were
:15:38. > :15:43.overridden by the political imperative and the access was --
:15:43. > :15:46.axis was powerful at the time. There was then a degree of
:15:46. > :15:51.overoptimism about the countries you could admit. It was quite clear
:15:51. > :15:55.that some countries and Italy was one, and Greece was another, were
:15:55. > :16:00.admitted when they did not fulfil the letter of the conditions, and
:16:00. > :16:05.that is now come back to haant them. I want to get on to learning the
:16:05. > :16:10.lessons of financial crisis, and the crisis in the eurozone, and I
:16:10. > :16:14.guess I don't just mean do they have a five point plan or a seven
:16:14. > :16:21.point plan for fixing it, but are the habits of mind, is the mind set
:16:21. > :16:26.that led to this, any sign that is changing? The problem with
:16:26. > :16:30.economics is the lack of recognition of imperfect
:16:30. > :16:37.understanding and the rule of miscop ception, misunderstandings,
:16:37. > :16:43.and the same applies, to politics. -- misconceptions. It is only only
:16:43. > :16:52.in economics that people work with imperfect understanding, the same
:16:52. > :16:58.is true in politics. So the euro was actually misconceived. It was
:16:58. > :17:03.based on the false understanding of how currencies work. You think it
:17:04. > :17:10.was a mistake? No, it was flawed but there is nothing special about
:17:10. > :17:17.the euro, because all our concepts are flawed. You see, so it just, it
:17:17. > :17:25.happened to be more flawed than most of the others, because it was
:17:25. > :17:35.built on the, on the idea that imbalances only occur in the public
:17:35. > :17:36.
:17:36. > :17:40.sector. So if you have too much, too big deficit in budgets, or that
:17:40. > :17:46.is where things can go wrong. only the Government that can get
:17:46. > :17:51.into trouble, it is like our previous discussion. And the
:17:51. > :18:00.trouble in the eurozone came also from the private sector, and there
:18:00. > :18:07.were no provision within the whole construct for that possibility, so
:18:07. > :18:12.by introducing a common currency the central bank accepted a
:18:12. > :18:18.Government bond of all the member states, and the same terms and
:18:18. > :18:26.conditions, and it was willing to lend against it. Against credit,
:18:26. > :18:31.the problem, the trouble with the, the collateral, and the credit, so
:18:31. > :18:39.you used all the Government bonds as collateral equally, and because
:18:39. > :18:45.of that, the interest rates in the various countries, began to
:18:45. > :18:55.coalesce, and the differentials went down from several percentage
:18:55. > :18:59.
:18:59. > :19:04.points to, to a few basis points, so let's say French and, and German
:19:04. > :19:14.banks would load up on Spanish bonds, or Italian bonds, because
:19:14. > :19:18.they yielded ten basis points more than the others. So they bought the
:19:18. > :19:26.actually, the... They were being treated be the same by the market
:19:26. > :19:33.bus they weren't the same. And that then created real estate booms in
:19:33. > :19:38.Spain and Ireland and so on, and now we have discovered that in fact
:19:38. > :19:44.they are not the same, and now the interest rate differential, the
:19:44. > :19:49.risk premiums have widened and there again now 3 or 4%. That is
:19:49. > :19:53.what is causing the crisis. So it is really the constructive --
:19:53. > :19:58.construction of the whole thing and the behaviour of the central bank
:19:58. > :20:03.that caused a lot of the problem, except I would say for Greece,
:20:03. > :20:10.which is a special case, because they took advantage of the
:20:10. > :20:16.structural funds, and there was, there were abuses there, but not in
:20:16. > :20:21.Spain. They handled things very responsibly, and yet they are now
:20:21. > :20:26.in a terrible crisis. Howard Davis, do you agree with that, and do you
:20:26. > :20:29.think they are getting closer to a solution to the problem f I mean,
:20:29. > :20:36.as George has described it you wouldn't start from here, but given
:20:36. > :20:39.we are here, do you think they have their heads round what needs to
:20:39. > :20:44.happen. The December cipsoufpb what went wrong, and it was assumed
:20:44. > :20:48.somehow that they were all the same credit risk, it was assumed that
:20:48. > :20:51.somehow the eurozone would come to the aid of individual countries
:20:51. > :20:56.even though there was nothing written down say they would, and
:20:56. > :21:01.now we are discovering the problem of that. It is a very tricky thing
:21:01. > :21:06.to get out of however, because ultimately, the big question is
:21:06. > :21:11.whether the central economies and roughly we meaner Germany plus are
:21:11. > :21:15.prepared to stand behind the credit of the southern European periphery,
:21:15. > :21:18.and the clearly in Germany, this debate is still going on, and the
:21:18. > :21:25.Germans are not keen to do so, because they point to morale hazard.
:21:25. > :21:28.They say what is to stop them going crazy again? So it is a very
:21:28. > :21:32.complicated solution. Do you think they, do you think that is likely,
:21:33. > :21:38.do you think you will get that kind of commitment to what we are might
:21:38. > :21:42.say is a fiscal union? I don't really agree a is by far the
:21:42. > :21:46.central problem. I think there are two other issues that are
:21:46. > :21:51.complicating the discussions and the fundment lals in Europe. One is
:21:51. > :21:54.that the European Central Bank is not willing to act as a lender of
:21:54. > :21:59.last resort. I understand why it is not willing, because that is a
:21:59. > :22:03.risky thing do and its credibility is not that well established yet,
:22:03. > :22:08.but I think until and unless it accepted that responsibility, to
:22:08. > :22:12.provide unlimited support to those solvent countries in Europe,
:22:12. > :22:16.through the secondary bond market and I am talking about Italy
:22:16. > :22:20.predominantly, Spain also, I don't think this crisis will be solved.
:22:20. > :22:24.The second issue and closely interrelated is one of the reasons
:22:24. > :22:28.the ECB is not willing to play that role and part of the German
:22:28. > :22:34.difficulty is that there is not a confidence that the countries that
:22:34. > :22:37.need to undertake structural reforms can actually do it.
:22:37. > :22:43.Politically speaking. Basically you have a situation where you have got
:22:43. > :22:49.one central bank, because you have one currency and you have different
:22:49. > :22:55.Governments, and effectively, the Governments o borrowing not in
:22:55. > :23:02.their own currency, but in a foreign currency, the euro, because
:23:02. > :23:08.they don't control the euro. As a result, actually Government bonds
:23:08. > :23:13.of the European countries carry more risk than, let's say the
:23:14. > :23:19.Government bonds of Britain. The economic conditions of Britain
:23:19. > :23:24.actually are much worse than the economic conditions of Spain, but
:23:24. > :23:30.the risk premium on Spanish bonds is higher, because Spain can't
:23:30. > :23:35.print its own money. Britain can print its own money. So, Britain
:23:35. > :23:43.has a central bank, and that is a big, big difference, and that is a
:23:43. > :23:53.flaw that needs to be somehow now repaired, so Europe faces a big,
:23:53. > :23:56.
:23:56. > :24:04.big change, it either the eurozone, it either moves closer to a common
:24:04. > :24:10.fiscal policy, or it will fall apart. If it falls apart, the
:24:10. > :24:14.consequences will be devastating, not only for the eurozone, but for