Have we all been ‘Minskyed?’


Some 20 years ago, on the brink of the cataclysm that scorched New Hampshire’s property markets and swallowed its largest banks, a friend found me toting “Stabilizing an Unstable Economy,” a book written by Hyman Minsky, an academic economist then teaching at Washington University in St. Louis. “Is he a Menshevik or a Bolshevik?” he asked. “A Keynesian,” I replied. “Even worse,” he remarked. Minsky fared no better by his professional colleagues — besotted with the harmony of unfettered markets and largess of financial innovation — who dismissed him as a radical, even a crackpot. Now, 12 years after his death, with Wall Street awash in toxic assets and littered with worthless paper, Minsky is hailed for divining the worm in the apple of modern capitalism. The Wall Street Journal reported that the book I read was offered on the Internet for “thousands of dollars” before it was recently reprinted. What Minsky called his “financial instability hypothesis” was drawn from his grasp of history and his reading of Keynes. His peers held that capitalism, driven by the forces of the market, was inherently stable and economic dislocations were the results of external shocks, like mistaken fiscal or monetary policy or misbehavior by OPEC. But Minsky, referring to the string of financial crises during the 19th century, the Great Depression of the 1930s and recurring slumps since 1965, countered that cycles of boom and bust were part and parcel of capitalism itself. “It is reasonable,” he wrote in 1977, “to view financial crises as systemic, rather than accidental, events.” Minsky found the source of instability in the workings of the investment cycle and the conduct of financial institutions amid “intractable uncertainty.” He describes a scenario that begins when the economy is thriving, and increases in the valuation of capital assets and the availability of debt financing trigger rising demand for investment financing. As the volume of borrowing grows, the market price of capital assets rises, encouraging more investment, spawning a “boom economy.” The belief that the future promises perpetual increases in operating profits and asset values ushers in what Minsky dubbed the “economics of euphoria,” marked by the willingness of investors to assume greater amounts of debt and of financiers — whom he playfully called “merchants of debt” — to lend to increasingly less creditworthy borrowers. Noting that “innovations in financial practices are a feature of our economy,” he explained that each new financial instrument increased the amount of available financing, bidding up the price of assets and fueling more investment. Minsky distinguished three kinds of financing: • “Hedge finance,” where cash flows are presumed sufficient to defray debt service • “Speculative finance,” where cash flows may cover interest payments, but continuous refinancings are required to repay the original loan • “Ponzi finance,” where cash flows fail to service the debt and the borrower relies on the appreciation of asset values to secure fresh borrowings to mask the debt. When the economy is stable, both hedge and speculative financing can be sustained. But, as investment increases interest rates rise, forcing hedge borrowers to become speculative borrowers and speculative borrowers to turn to Ponzi finance. “Over a protracted period of time,” Minsky concluded, “capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is a large weight to units engaged in speculative and Ponzi finance.” The euphoric period is short-lived. As prescient traders begin taking profits and higher interest rates squeeze marginal borrowers, asset values fall and loan defaults rise. Euphoria is overtaken by panic. Minsky believed the ruinous effects of this recurrent cycle could be mitigated by effective regulation and timely intervention by the federal government and Federal Reserve. Consequently, when the Reagan administration embarked on a program of easing the regulation of financial institutions, he warned that the “Reagan road is unfortunately not the right way to go.” Spurned by his peers, Minsky has been vindicated by economic reality, moving John Cassidy, writing in The New Yorker a year ago, to declare our present plight “The Minsky Moment.” Meanwhile, my friend, who found himself between jobs when I reminded him of our conversation, confessed, “I’ve been Minskyed.”

Michael Kitch, a former reporter for New Hampshire Business Review, works for the Laconia Daily Sun.