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Mallaby argues that hedge funds, not investment banks, were the less dangerous part of the financial system. Their managers had their own wealth in the fund and faced no bailout, so losses fell on the partners and investors who chose the risk. Most hedge funds that failed, even large ones like Amaranth, collapsed without spreading damage, while banks that were too big to fail and backed by implicit guarantees became the real threat.
In 1992 Stanley Druckenmiller saw that Britain could not raise interest rates to defend sterling's peg without deepening its recession. The downside was capped because the pound would not be revalued upward, and the upside was large once the peg broke. Speculators had found that a fixed exchange rate out of line with the domestic economy is a one-way bet against the central bank that defends it.
Soros held that market participants' biased perceptions feed back into the reality they are trying to value, for example when rising stock prices let firms raise cheap capital and so improve the earnings that justified the prices. This feedback loop produces self-reinforcing booms and busts rather than a drift toward equilibrium. The trader's job is to spot when a trend is feeding on itself and when the gap between perception and reality has grown wide enough to snap back.
Many durable hedge fund profits came from trading against participants who were forced to act, not from superior forecasting. Examples include central banks defending pegs, index funds that must rebalance, and banks under capital rules. Once you see the market this way, the question becomes who has to buy or sell regardless of price, and when an edge is widely known it erodes, as crowded quant trades showed in 2007.