It is better to lead revolutions than to be conquered by them.
A lesson from the technology industry is that it’s better to be in front of a big change than to be behind it.
He who does not risk, does not drink champagne.
On August 9, 2007, BNP Paribas froze withdrawals from three of its funds. Fearing that move would halt interbank lending, the world’s worried central bankers, led by the European Central Bank’s Jean-Claude Trichet, pumped billions into global money markets. Those twin steps eventually came to be viewed as the opening shot in the global credit crisis.
Eight days later, George Soros hosted twenty of Wall Street’s most influential investors for lunch at his Southampton estate, on the eastern end of Long Island. It was a warm but overcast Friday afternoon. As the group dined on Long Island striped bass, fruit salad, and cookies, their tone was serious and rather formal. The meal was one of two annual “Benchmark Lunches,” held on successive Fridays in late August and organized by Byron Wien, a Wall Street veteran who had befriended Soros four decades earlier thanks to a shared interest in then obscure Japanese stocks.
James Chanos, the influential short hedge fund manager, was one of the guests. It was a group, Chanos told me, of “pretty heavyweight investors.” Other diners included Julian Robertson, legendary founder of the Tiger Management hedge fund; Donald Marron, the former chief executive of PaineWebber and now boss of Lightyear Capital; and Leon Black, cofounder of the Apollo private equity group.
In a memo about the luncheon discussion he distributed a few weeks later, Wien wrote that the talk focused on one issue: “Were we about to experience a recession?” We all know the answer today. But just over a year before the collapse of Lehman Brothers definitively plunged the world into the most profound financial crisis since the Great Depression, the private consensus among this group of Wall Street savants was that we were not. According to Wien’s memo, “The conclusion was that we were probably in an economic slowdown and a correction in the market, but we were not about to begin a recession or a bear market.”
Only two of the twenty-one participants had dissented from that bullish view. One of the bears was Soros. “George was formulating the idea that the world was coming to an end,” Wien recalled. Far from being won over by his friends, Soros saw their optimism as reinforcing his fears. He left the lunch convinced that the global financial crisis he had been predicting prematurely for years had finally begun.
His conclusion had immediate and practical consequences. Soros had been one of the world’s most successful and most influential investors: for the thirty years from 1969 through 2000, Soros’s Quantum Fund returned investors an average of 31 percent a year. Ten thousand dollars invested with Soros in 1969 would have been worth $43 million by 2000. According to a study by LCH Investments, a fund owned by the Edmond de Rothschild Group, during his professional career Soros has been the world’s most successful investor, earning, as of 2010, a greater total profit than Warren Buffett, the entire Walt Disney Company, or Apple.
But in 2000, following the departure of Stan Druckenmiller, who had been running Quantum, Soros stepped back from active fund management. Instead, he recalled, “I converted my hedge fund into a less aggressively managed vehicle and renamed it an ‘endowment fund’ whose primary task was to manage the assets of my foundations.”
On August 17, 2007, he realized he had to get back in the game. “I did not want to see my accumulated wealth be severely impaired,” Soros told me during a two-hour conversation in December 2008 in his thirty-third- floor conference room in midtown Manhattan, with views overlooking Central Park. “So I came back and set up a macro account within which I counterbalanced what I thought was the exposure of the firm.”
Soros complained that his years of semiretirement meant he didn’t have the kind of “detailed knowledge of particular companies I used to have, so I’m not in a position to pick stocks.” Moreover, “even many of the macro instruments that have been recently invented were unfamiliar to me.” At the moment he made his crisis call, Soros was so disengaged from daily trading that he didn’t even know what credit default swaps—the now notorious derivatives that brought down insurance giant AIG—were. Even so, his intervention was sufficient to deliver a 32 percent return for Quantum in 2007, making the then seventy-seven-year-old the second-highest-paid hedge fund manager in the world, according to Institutional Investor’s
The twenty more bullish guests at the Soros table that August afternoon weren’t outliers. They reflected the consensus view of corporate America’s top economists. When the
Alan Greenspan was so wrong-footed by the crash of 2008 that he admitted intellectual defeat. “I made a mistake,” he told a congressional committee on October 23, 2008. “Something which looked to be a very solid edifice, and indeed a critical pillar to market competition and free markets, did break down. And I think that, as I said, shocked me.”
Hindsight makes all of us Einsteins. With the wisdom it bestows, it is easy to mock and malign the actions and the explanations of the Fulds and the Greenspans. But in 2007 and early 2008, inertia—whether you believe it to have been motivated by avariciousness or incompetence—was the normal response. While the bubbles are easy to identify in retrospect, when we are caught up in them, most of us find it difficult to imagine they will ever burst. And even those of us who are intellectually honest and experienced enough to appreciate that, one day, the boom is bound to end, find it tough to act on that realization.
It is not just financial crashes we have a hard time anticipating. Significant paradigm shifts more generally— revolutions in politics and society, as well as those in business and the markets—are notoriously hard to foresee. The CIA famously failed to predict the collapse of the Soviet Union. Less than a year before Hosni Mubarak was toppled, the IMF published a report lauding his economic reforms and the stability they had created. Mike McFaul, a political scientist who was appointed U.S. ambassador to Russia in 2011, believes that “we always assume regime stability and when it comes to authoritarian regimes we are always wrong.”
Even after the revolution has begun—after the first overleveraged bank freezes withdrawals from its riskiest fund, after the protesters win their first important standoff against the soldiers of the ruling regime—most of us are reluctant to admit that the world has changed. As historian Richard Pipes observed, after the Bolsheviks seized power in 1917, prices on the Petrograd stock exchange remained stable. And once we recognize that the world has changed, most of us are very bad at adapting our behavior to the new reality.
Instead, according to London Business School professor Donald Sull, most companies respond to revolutionary change by doing what they did before, only more energetically. Sull calls this “active inertia” and he believes it is the main reason good companies fail: “When the world changes, organizations trapped in active inertia do more of the same. A little faster perhaps or tweaked at the margin, but basically the same old same old…. Organizations trapped in active inertia resemble a car with its back wheels stuck in a rut. Managers step on the gas. Rather than escape the rut, they only dig themselves in deeper.”
Clayton Christensen, the Harvard Business School professor whose book
