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Why Minsky matters

from Lars Syll

In an often cynical world, standard financial and macroeconomic quantitative models give people the benefi t of the doubt. Fundamental economic theory assumes the best of us, supposing that human beings are perfectly rational, know all the facts of a given situation, understand the risks, and optimize our behavior and portfolios accordingly. Reality, of course, is quite different. While a significant portion of individual and market behavior can be modeled reasonably well, the human emotions that drive cycles of fear and greed are not predictable and can often defy historical precedent. As a result, quantitative models sometimes fail to anticipate major macroeconomic turning points. The ongoing debt crisis in Europe is the most recent example of an extreme event shattering historical norms.

kindleOnce an extreme event occurs, standard models offer limited insight as to how the ensuing crisis could play out and how it should be managed, which is why policy responses can seem disjointed. The latest policy responses to the European crisis have been no exception. To understand and respond to a crisis like the one in Europe, perhaps we need to consider some new models that include the “human factor.” Economic historian Charles Kindleberger can offer some insight. In his book Manias, Panics, and Crashes, Kindleberger explores the anatomy of a typical financial crisis and provides a framework that considers the impact of the powerful human dynamics of fear and greed. Kindleberger’s descriptive process of the boom and bust liquidity cycle can help shed light on the current European sovereign debt saga, and perhaps illuminate whether we have in fact turned the corner on this financial crisis.

Kindleberger analyzed hundreds of financial crises dating back centuries and found them to share a common sequence of events, one that followed monetary theorist Hyman Minsky’s model of the instability of a credit system. Fundamentally, the more stable and prosperous an economic structure appears, the more leverage and speculative financing will build within the system, eventually making it highly vulnerable to a surprising, extreme collapse. Kindleberger provided the qualitative (as opposed to quantitative!) description of the Minsky Model, shown below, which is a useful snapshot of the liquidity cycle. It can be applied to Europe and any potential boom/bust candidate, including Chinese real estate, commodity prices, or investors’ recent love affair with emerging markets. Kindleberger famously dubbed this sequence a “hardy perennial,” probably because the galvanizing human conditions of fear and greed are more often than not prone to overshoot fundamental values compared to the behavior of a rational individual, which exists only in macroeconomic theory.


Loomis Sayles

hymanFor more on Minsky, listen to BBC 4 where Duncan Weldon explains in what way Hyman Minsky’s thoughts on banking and finance offer a radical challenge to mainstream economic theory.

As a young research stipendiate in the U.S. thirty years ago, yours truly had the great pleasure and privelege of having Hyman Minsky as teacher.

He was a great inspiration at the time.

He still is.

  1. patrick newman
    January 28, 2017 at 3:45 pm

    Lender of last resort restores order by promising liquidity and by socialising private debt – any takers?

    • originalsandwichman
      January 28, 2017 at 6:39 pm

      Restores order… but at lower level of profitability, etc. etc. Rinse and repeat.

    • February 1, 2017 at 11:28 am

      This is what we have got – what we HAVE taken (still not taking account of our “debt” to Nature) – not what we ought to have, i.e. not Big Banking but a (credit card) system making us aware of our personal responsibilities in socialised repayment of our debts to each other AND (given the looming threat from global warming) to Nature.

      But Minsky matters. “For more on Minsky, listen to BBC 4”, i.e. follow Lars’ link, where Minsky himself puts the structure of the cycle even more simply: “Hedge, Speculate, Ponzi, restart”; and Steve Keen among others comment.

  2. February 1, 2017 at 6:38 am

    And what does society and we “ordinary folk” get in return for enduring all this threat, fear, dislocation, and wrecking of our lives?

  3. February 5, 2017 at 11:09 pm

    The bail out of our financial system by the Obama Admin and Ben Bernanke’s Fed didn’t quite follow the Democratic blueprint layed out during FDR’s New Deal (with Jesse Jones’ RFC) — and was followed by the Bush Admin during the S&L fiasco — where individuals as well as institutions were punished, thus upholding some sort of moral hazard argument.

    Wall Street got bailed out — and needed to be bailed out — Main Street did not get much of a bailout. And now we wound up with Trump.

    • February 6, 2017 at 6:01 am

      I’ve thought about and researched the “financial bailout” by the government a lot. The bailout was begun by Bush and continued by Obama. As President Obama said about it, we really have no choice. By the time the banks and financial houses were near to destroying themselves, the choices were simple – let them fail and then pick up the pieces, or stop them from failing. Picking up the pieces is a euphemism for a lot of ordinary people’s lives will be ruined. So we held our noses and bailed them out. If they had been regulated properly to begin with it’s likely the crisis could have been prevented rather than “managed” with lots of taxpayer money. Turns out, millions of lives of ordinary folks were still ruined, the banks and financial houses continued business as usual (they did pay back the US Treasury), and years of continuing assistance (e.g, QE) were launched to get a recovery from the screw ups these guys created, and from which we are all still suffering. If it had been my call, most of the guys in charge at the financial institutions would be in jail for the next 25 years and the banks would be nationalized.

      • February 6, 2017 at 6:23 am

        That’s how it was handled during the New Deal and the S&L fiasco.

  4. February 6, 2017 at 9:46 am

    You know what they say. Fool me once, shame on you. Fool me twice, shame on me. In a speech to a gathering of bankers in 1834 Andrew Jackson said, “You are a den of vipers and thieves, and by the Eternal, I will rout you out.” Unlike Jackson I do see a need for banks. But those banks need to be regularly and tightly regulated. After all, in the words of Mark Twain, “There are several good protections against temptations, but the surest is cowardice.” Someone looking over your shoulder brings on such cowardice. I want banker to know they’re being watched. After all, they have the future of the world in their hands.

    As for the New Deal, at least the Emergency Banking Act actually got money back to bank depositors, rather than shareholders. The S&L bailout was a disaster. It mostly gave money to local politicians and hucksters (like Donald Trump) who had scammed the thrifts. I knew two politicians in TX and LA who received about $3 million from local thrifts based on deposits that never existed.

  5. patrick newman
    February 6, 2017 at 11:02 am

    The UK is passing up a wonderful opportunity to ‘sort out’ large banks. The government currenty owns 73% of RBS which prior to the 2007/8 crisis was the largest bank in the world. You would not know it as the government is obsessively hands off. It could turn the bank into an exemplar for customers, society and the economy in which a supervisory board could have staff, customers and HM Treasury as members and profits invested in projects in the national interest but setting the pace and standards for all the other privately owned banks! It is Right wing ideology that prevents such a sensible proposal being carried forward.

    • February 7, 2017 at 5:36 am

      What is the counter-narrative for the right wing ideology? It’s long past time to fight fire with fire. Ideologues of the right, even as far as fascists have used lots of money, propagandists, and “realpolitik” to subvert and misdirect, character assassinate, and bully their way to power and shortly I think to control. During WWII the US engaged in a massive “education” campaign to get the American population on board with the war. The American Historical Association (think top anti-propagandist) even wrote a pamphlet, “What is Propaganda.” Even Disney got into the work, with dozens of animated films. And of course many of us have seen the film series made by Frank Capra, “Why we Fight.” We need such an effort today to counter and push out the new generation of fascists that threaten us now. If that means upsetting the capitalist apple cart, so be it. No big loss. If that means destroying capitalism, no loss. Really no big deal.

  6. February 6, 2017 at 7:28 pm

    Minsky is one of the few economists quoted by pundits on both the left and the right (no, I am not going to count Milton Friedman – you don’t get to call yourself left if you quote Friedman in support of your ideas). The main difference is, when the right quotes Minsky they talk of confidence and when the left quotes him they talk about stockpiles of assets in the hands of investors.

    The other, of course, is Pigou.

    • February 7, 2017 at 5:55 am

      There may be an opportunity here. Confidence is not a bad thing. Neither are assets. Studying them may help us figure out how to spread the former more widely, and distribute the latter more equally. Both can help make democracy better and to protect it. Quite frankly no economic system is worth endangering or harming democracy.

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