Posted: Mar 24, 2014 9:57 am
by Macdoc
Did Hyman Minsky find the secret behind financial crashes?
Hyman Minsky

American economist Hyman Minsky, who died in 1996, grew up during the Great Depression, an event which shaped his views and set him on a crusade to explain how it happened and how a repeat could be prevented, writes Duncan Weldon.

Minsky spent his life on the margins of economics but his ideas suddenly gained currency with the 2007-08 financial crisis. To many, it seemed to offer one of the most plausible accounts of why it had happened.

His long out-of-print books were suddenly in high demand with copies changing hands for hundreds of dollars - not bad for densely written tomes with titles like Stabilizing an Unstable Economy.

Senior central bankers including current US Federal Reserve chair Janet Yellen and the Bank of England's Mervyn King began quoting his insights. Nobel Prize-winning economist Paul Krugman named a high profile talk about the financial crisis The Night They Re-read Minsky.

Here are five of his ideas.

Stability is destabilising
Minsky's main idea is so simple that it could fit on a T-shirt, with just three words: "Stability is destabilising."

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Most macroeconomists work with what they call "equilibrium models" - the idea is that a modern market economy is fundamentally stable. That is not to say nothing ever changes but it grows in a steady way.

To generate an economic crisis or a sudden boom some sort of external shock has to occur - whether that be a rise in oil prices, a war or the invention of the internet.

Minsky disagreed. He thought that the system itself could generate shocks through its own internal dynamics. He believed that during periods of economic stability, banks, firms and other economic agents become complacent.

They assume that the good times will keep on going and begin to take ever greater risks in pursuit of profit. So the seeds of the next crisis are sown in the good time.

Three stages of debt
Minsky had a theory, the "financial instability hypothesis", arguing that lending goes through three distinct stages. He dubbed these the Hedge, the Speculative and the Ponzi stages, after financial fraudster Charles Ponzi.

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Ponzi schemes
Charles Ponzi
Similar to a pyramid scheme, an enterprise where - instead of genuine profits - funds from new investors are used to pay high returns to current investors.

Named after fraudster Charles Ponzi (1882-1949), such schemes are destined to collapse as soon as new investment tails off or significant numbers of investors simultaneously wish to withdraw funds.

In the first stage, soon after a crisis, banks and borrowers are cautious. Loans are made in modest amounts and the borrower can afford to repay both the initial principal and the interest.

As confidence rises banks begin to make loans in which the borrower can only afford to pay the interest. Usually this loan is against an asset which is rising in value. Finally, when the previous crisis is a distant memory, we reach the final stage - Ponzi finance. At this point banks make loans to firms and households that can afford to pay neither the interest nor the principal. Again this is underpinned by a belief that asset prices will rise.

The easiest way to understand is to think of a typical mortgage. Hedge finance means a normal capital repayment loan, speculative finance is more akin to an interest-only loan and then Ponzi finance is something beyond even this. It is like getting a mortgage, making no payments at all for a few years and then hoping the value of the house has gone up enough that its sale can cover the initial loan and all the missed payments. You can see that the model is a pretty good description of the kind of lending that led to the financial crisis.

Minsky moments
The "Minsky moment", a term coined by later economists, is the moment when the whole house of cards falls down. Ponzi finance is underpinned by rising asset prices and when asset prices eventually start to fall then borrowers and banks realise there is debt in the system that can never be paid off. People rush to sell assets causing an even larger fall in prices.

Wiley Coyote in "Chariots of Fur", 1994
The Minsky moment: Like the moment when the cartoon character realises they're running on thin air
It is like the moment that a cartoon character runs off a cliff. They keep on running for a while, still believing they're on solid ground. But then there's a moment of sudden realisation - the Minsky moment - when they look down and see nothing but thin air. Then they plummet to the ground, and that's the crisis and crash of 2008.


And it's happening all over again in various economies notably Britain and Canada where over priced home values have created a bubble.....

The dismantling of the barriers between finance, insurance, mortgages and banks have led to too much concentration no consideration for the public weal.

Yet banks are only able to pull the shite they do because they are chartered by the public ( aka gov't ) to be able to undertake fractional lending and leverage their capital and other people''s money 30+ times.

Like owning one house and renting it out 30 the same time legally and by government charter. :scratch: :what:

Nice deal they cut.

Meanwhile small and medium business that are actual wealth and job creators struggle for financing and are forced into the costly credit card realm where once more the banks rake it in.

Borrowing at insanely low rates, paying interest at insanely low rates, but nary a blush at collecting 17-21% interest on credit card debt. :nono:

Fucked system....gonna break again and again until these Ponzi scheme builders are sent to jail and the banks are taken out of speculation.

Just as other concentrations got busted up early in the last century - time to reign in the predators in the financial world
Fines handed out are just the cost of doing business....they could care less. :coffee: