Another Minsky moment
Forget the living canon of great economists – Paul Krugman, Joe Stiglitz, Larry Summers and the rest. Hyman Minsky was the only contemporary thinker to have predicted with uncanny precision the global financial crisis. This is no small achievement since Minsky died more than a decade before Lehman Brothers filed for bankruptcy. Minsky’s unorthodox vision of capitalism, with its emphasis on the central role of finance and the system’s inherent tendency to crash, was vindicated by the subprime crisis.
In a new book, “Why Minsky Matters: An Introduction to the Work of a Maverick Economist,” L. Randall Wray suggests that he would have approved of policymakers’ initial response to the crisis precipitated by Lehman’s collapse in the fall of 2008. However, by now, Minsky would be fretting that another “Minsky moment” is not far away and pondering what lies ahead.
Minsky, who taught economics at the University of Washington in St Louis before ending up at the Levy Institute at Bard College, had little time for conventional economics with its emphasis on equilibrium, rational expectations and the view that money and finance were largely irrelevant: “Nobody ‘up there’ understands American capitalism,” he once contemptuously wrote.
For Minsky, the “real economy” was a veil distracting us from analyzing all the important activities of finance. In his description, the economy is comprised of a complex network of balance sheets and cash flows, which link together all economic agents, including government, financial institutions, firms and households. Minsky held that this network becomes more fragile over time as people take on increasing amounts of risk.
Prudent financial arrangements give way to what he called “Ponzi finance,” which describes the situation when borrowers are unable to service their debts or repay principal from their current income. Ponzi borrowers depend on refinancing against the collateral of rising asset prices to maintain solvency. Long before former Fed Chairman Ben Bernanke and other economists hailed the “Great Moderation” of low inflation and stable growth, Minsky elaborated the “Financial Instability Hypothesis.” This is expressed in his trademark comment – “stability is destabilizing” – since, as Minsky argued, people respond to good times by changing their risk preferences.
When the credit crunch arrived, it provided posthumous support for Minsky’s economic vision. Subprime mortgages were revealed as a classic form of Ponzi finance. Losses of securitized debt cascaded through the financial system, prompting a liquidity crisis, exactly as described in Minsky’s work. The Great Moderation gave way to the Great Recession, and the Lehman bust became known as the ultimate example of a “Minsky moment.”
As a result, the crisis made Minsky something of a household name beyond strictly economic circles. Unfortunately, Minsky in the original isn’t an easy read. “He needs to be translated,” writes Wray, in the preface to “Why Minsky Matters.” As a former teaching assistant of Minsky’s and colleague at the Levy Institute, Wray is perfectly positioned to perform that task. Few people understand Minsky as well as Wray. Written in clear prose, with Minsky’s idiosyncratic ideas and language patiently explained, Wray provides the best general introduction to Minsky’s economics.
In the second half of the book, Wray discusses how his mentor might have viewed developments since the global financial crisis. In his view, there’s no doubt Minsky would have endorsed vast fiscal deficits, the rapid reduction in interest rates and the Fed’s provision of liquidity during the crisis period. He believed that such actions were necessary to avoid a rerun of the Great Depression.
Yet Minsky would have disapproved of much that has happened. The return of reckless financial behavior, soaring inequality and the failure to reform Wall Street in a fundamental way, would all have attracted his ire.
Minsky believed that crises serve an important role by making people more cautious – instability is stabilizing, so to speak. The searing experience of the Great Depression made the next generation of Americans financially risk averse. In addition, the New Deal reforms of the early 1930s changed the nature of the financial system. Commercial and investment banking were separated. Deposit insurance brought bank runs to an end. After the depression, banking became more prudent than it had been in the roaring twenties. These developments, combined with a low level of private debt, made for a relatively robust postwar financial system.
The striking thing about the aftermath of the latest crisis is how little has changed. True, there’s been a mass of new regulations with the Dodd-Frank Act and so forth. But institutionally, things are much the same. The too-big-to-fail banks, which Minsky deplored, have gotten even bigger. “Money manager capitalism,” the latest phase in capitalist development described by Minsky in his last years, emerged largely unscathed. Hedge fund assets are bigger than ever. Credit continues to be created and held outside the traditional banking system. For instance, billions of dollars are now tied up in bank loan ETFs.
Nor did the financial crisis change behavior. The Fed’s safety net was so encompassing that, as Minsky would have predicted, rashness soon returned to Wall Street, with a resurgence of debt-fuelled buybacks and M&A, record issuance of covenant-lite loans, a rapid decline in junk-bond quality, and some $1 trillion worth of emerging market corporate debt, much of it denominated in foreign currencies. While parts of the system have deleveraged, aggregate nonfinancial debt levels, both in the United States and globally, have kept climbing ever higher.
In Minsky’s world, policymakers are caught between a rock and a hard place. Capitalism is fundamentally unstable and prone to crises. If the authorities stand aside during the emergency, another Great Depression beckons. However, if they intervene then destabilizing activities are rewarded and encouraged. More financial regulation is no panacea. According to Minsky, clever financiers will always find ways around existing regulations, however extensive. Capitalism is doomed to an endless cycle of boom and bust.
During Minsky’s prime of the 1960s and 1970s successful crisis interventions by government paved the way for inflation. Yet in the post-Lehman world, deflation has proved remarkably difficult to dispel, despite the best efforts of central bankers.
The lack of institutional reform on Wall Street and the revival of casino capitalism suggest another “Minsky moment” may be just around the corner. But how the next crisis pans out is less certain. With global debt at record levels and interest rates at all-time lows, the world has entered new territory. Even the great Minsky would struggle to predict what happens next.