Hyman Minsky
Encyclopedia
Hyman Philip Minsky was an American
economist
and professor
of economics
at Washington University in St. Louis
. His research attempted to provide an understanding and explanation of the characteristics of financial crises
. Minsky was sometimes described as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets and opposed some of the popular deregulation
policies in the 1980s, and argued against the accumulation of debt
. His research was noticed by Wall Street
.
emigrants from Belarus
. His mother, Dora Zakon, was active in the nascent trade union
movement; his father, Sam Minsky, was active in the Jewish section of the Socialist party
of Chicago
. In 1941, Minsky received his B.S.
in mathematics
from the University of Chicago
and went on to earn an M.P.A.
and a Ph.D.
in economics
from Harvard University
, where he studied under Joseph Schumpeter
and Wassily Leontief
.
from 1949 to 1958, and from 1957 to 1965 was an Associate Professor of Economics at the University of California, Berkeley
. In 1965 he became Professor of Economics of Washington University in St Louis and retired from there in 1990. At the time of his death he was a Distinguished Scholar at the Levy Economics Institute of Bard College
.
while he was an Associate Professor of Economics at the University of California, Berkeley.
fragility, in the normal life cycle
of an economy
, with speculative
investment bubbles endogenous
to financial markets. Minsky claimed that in prosper
ous times, when corporate cash flow
rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis
. As a result of such speculative borrowing bubbles, bank
s and lenders tighten credit availability, even to companies that can afford loan
s, and the economy
subsequently contracts.
This slow movement of the financial system from stability to fragility, followed by crisis, is something for which Minsky is best known, and the phrase "Minsky moment
" refers to this aspect of Minsky's academic work.
"He offered very good insights in the '60s and '70s when linkages between the financial markets and the economy were not as well understood as they are now," said Henry Kaufman
, a Wall Street money manager and economist. "He showed us that financial markets could move frequently to excess. And he underscored the importance of the Federal Reserve as a lender of last resort
."
Minsky's model of the credit
system, which he dubbed the "financial instability hypothesis" (FIH), incorporated many ideas already circulated by John Stuart Mill
, Alfred Marshall
, Knut Wicksell
and Irving Fisher
. "A fundamental characteristic of our economy," Minsky wrote in 1974, "is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycle
s."
Disagreeing with many mainstream economists of the day, he argued that these swings, and the booms and busts that can accompany them, are inevitable in a so-called free market economy
– unless government steps in to control them, through regulation
, central bank
action and other tools. Such mechanisms did in fact come into existence in response to crises such as the Panic of 1907
and the Great Depression
. Minsky opposed the deregulation
that characterized the 1980s.
It was at the University of California at Berkeley that seminars attended by Bank of America
executives helped him to develop his theories about lending and economic activity, views he laid out in two books, John Maynard Keynes (1975), a classic study of the economist and his contributions, and Stabilizing an Unstable Economy (1986), and more than a hundred professional articles.
or in central bank
policy.
Minsky stated his theories verbally, and did not build mathematical models based on them. Consequently, his theories have not been incorporated into mainstream economic models, which do not include private debt as a factor. The post-Keynesian economist Steve Keen
has recently developed models of endogenous economic crises based on Minsky's theories, but they are currently at the research stage and do not enjoy widespread use.
Minsky's theories, which emphasize the macroeconomic dangers of speculative bubbles
in asset prices, have also not been incorporated into central bank policy. However, in the wake of the financial crisis of 2007–2010 there has been increased interest in policy implications of his theories, with some central bankers advocating that central bank policy include a Minsky factor.
of the late 2000s.
Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge
borrowers, speculative
borrowers, and Ponzi borrowers.
The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments. For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi
, see also Ponzi scheme
) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat. Because of the unlikelihood of most investments' capital gains being enough to pay interest and principal, much of this type of finance is fraudulent.
If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes
, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.
described how Minsky's hypothesis translates to the subprime mortgage crisis
. McCulley illustrated the three types of borrowing categories using an analogy from the mortgage market: a hedge borrower would have a traditional mortgage loan
and is paying back both the principal and interest; the speculative borrower would have an interest-only loan
, meaning they are paying back only the interest and must refinance later to pay back the principal; and the ponzi borrower would have a negative amortization
loan, meaning the payments do not cover the interest amount and the principal is actually increasing. Lenders only provided funds to ponzi borrowers due to a belief that housing values would continue to increase.
McCulley writes that the progression through Minsky's three borrowing stages was evident as the credit and housing bubbles built through approximately August 2007. Demand for housing was both a cause and effect of the rapidly-expanding shadow banking system
, which helped fund the shift to more lending of the speculative and ponzi types, through ever-riskier mortgage loans at higher levels of leverage. This helped drive the housing bubble, as the availability of credit encouraged higher home prices. Since the bubble burst, we are seeing the progression in reverse, as businesses de-leverage, lending standards are raised and the share of borrowers in the three stages shifts back towards the hedge borrower.
McCulley also points out that human nature is inherently pro-cyclical, meaning, in Minsky's words, that "from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes, the economic system's reactions to a movement of the economy amplify the movement – inflation feeds upon inflation and debt-deflation feeds upon debt deflation." In other words, people are momentum
investors by nature, not value investors. People naturally take actions that expand the high and low points of cycles. One implication for policymakers and regulators is the implementation of counter-cyclical policies, such as contingent capital requirements for banks that increase during boom periods and are reduced during busts.
, and unlike most economists, took seriously Keynes' idea that economics could be conducive to a more peaceful world. Minsky, elucidating a personal interpretation in his book John Maynard Keynes (1975), claimed that the adoption of the neoclassical synthesis
had diluted Keynes’ message. Notably, he placed a greater focus on the notion of Knightian uncertainty
, which "does not deal with risks that are insurable or analogous to gambling risks".
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
and professor
Professor
A professor is a scholarly teacher; the precise meaning of the term varies by country. Literally, professor derives from Latin as a "person who professes" being usually an expert in arts or sciences; a teacher of high rank...
of economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
at Washington University in St. Louis
Washington University in St. Louis
Washington University in St. Louis is a private research university located in suburban St. Louis, Missouri. Founded in 1853, and named for George Washington, the university has students and faculty from all fifty U.S. states and more than 110 nations...
. His research attempted to provide an understanding and explanation of the characteristics of financial crises
Financial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
. Minsky was sometimes described as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets and opposed some of the popular deregulation
Deregulation
Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
policies in the 1980s, and argued against the accumulation of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
. His research was noticed by Wall Street
Wall Street
Wall Street refers to the financial district of New York City, named after and centered on the eight-block-long street running from Broadway to South Street on the East River in Lower Manhattan. Over time, the term has become a metonym for the financial markets of the United States as a whole, or...
.
Education
A native of Chicago, Illinois, Minsky was born into a family of MenshevikMenshevik
The Mensheviks were a faction of the Russian revolutionary movement that emerged in 1904 after a dispute between Vladimir Lenin and Julius Martov, both members of the Russian Social-Democratic Labour Party. The dispute originated at the Second Congress of that party, ostensibly over minor issues...
emigrants from Belarus
Belarus
Belarus , officially the Republic of Belarus, is a landlocked country in Eastern Europe, bordered clockwise by Russia to the northeast, Ukraine to the south, Poland to the west, and Lithuania and Latvia to the northwest. Its capital is Minsk; other major cities include Brest, Grodno , Gomel ,...
. His mother, Dora Zakon, was active in the nascent trade union
Trade union
A trade union, trades union or labor union is an organization of workers that have banded together to achieve common goals such as better working conditions. The trade union, through its leadership, bargains with the employer on behalf of union members and negotiates labour contracts with...
movement; his father, Sam Minsky, was active in the Jewish section of the Socialist party
Socialist Party USA
The Socialist Party USA is a multi-tendency democratic-socialist party in the United States. The party states that it is the rightful continuation and successor to the tradition of the Socialist Party of America, which had lasted from 1901 to 1972.The party is officially committed to left-wing...
of Chicago
Chicago
Chicago is the largest city in the US state of Illinois. With nearly 2.7 million residents, it is the most populous city in the Midwestern United States and the third most populous in the US, after New York City and Los Angeles...
. In 1941, Minsky received his B.S.
Bachelor of Science
A Bachelor of Science is an undergraduate academic degree awarded for completed courses that generally last three to five years .-Australia:In Australia, the BSc is a 3 year degree, offered from 1st year on...
in mathematics
Mathematics
Mathematics is the study of quantity, space, structure, and change. Mathematicians seek out patterns and formulate new conjectures. Mathematicians resolve the truth or falsity of conjectures by mathematical proofs, which are arguments sufficient to convince other mathematicians of their validity...
from the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
and went on to earn an M.P.A.
Master of Public Administration
The Master of Public Administration is a professional post-graduate degree in Public Administration. The MPA program prepares individuals to serve as managers in the executive arm of local, state/provincial, and federal/national government, and increasingly in nongovernmental organization and...
and a Ph.D.
Doctor of Philosophy
Doctor of Philosophy, abbreviated as Ph.D., PhD, D.Phil., or DPhil , in English-speaking countries, is a postgraduate academic degree awarded by universities...
in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
from Harvard University
Harvard University
Harvard University is a private Ivy League university located in Cambridge, Massachusetts, United States, established in 1636 by the Massachusetts legislature. Harvard is the oldest institution of higher learning in the United States and the first corporation chartered in the country...
, where he studied under Joseph Schumpeter
Joseph Schumpeter
Joseph Alois Schumpeter was an Austrian-Hungarian-American economist and political scientist. He popularized the term "creative destruction" in economics.-Life:...
and Wassily Leontief
Wassily Leontief
Wassily Wassilyovich Leontief , was a Russian-American economist notable for his research on how changes in one economic sector may have an effect on other sectors. Leontief won the Nobel Committee's Nobel Memorial Prize in Economic Sciences in 1973, and three of his doctoral students have also...
.
Career
Minsky taught at Brown UniversityBrown University
Brown University is a private, Ivy League university located in Providence, Rhode Island, United States. Founded in 1764 prior to American independence from the British Empire as the College in the English Colony of Rhode Island and Providence Plantations early in the reign of King George III ,...
from 1949 to 1958, and from 1957 to 1965 was an Associate Professor of Economics at the University of California, Berkeley
University of California, Berkeley
The University of California, Berkeley , is a teaching and research university established in 1868 and located in Berkeley, California, USA...
. In 1965 he became Professor of Economics of Washington University in St Louis and retired from there in 1990. At the time of his death he was a Distinguished Scholar at the Levy Economics Institute of Bard College
Levy Economics Institute
The Levy Economics Institute of Bard College is located on the campus of Bard College, in Annandale-on-Hudson, New York. The Institute is housed in Blithewood, a mansion originally designed by an alumnus of the architectural firm of McKim, Mead and White for Andrew Zabriskie in 1899...
.
Commission on Money and Credit (1957-1961)
Minsky was a consultant to the Commission on Money and CreditCommission on Money and Credit
A national Commission on Money and Credit was established November 21, 1957, by Donald K. David, Chairman of the Committee for Economic Development ,...
while he was an Associate Professor of Economics at the University of California, Berkeley.
Financial theory
Minsky proposed theories linking financial marketFinancial market
In economics, a financial market is a mechanism that allows people and entities to buy and sell financial securities , commodities , and other fungible items of value at low transaction costs and at prices that reflect supply and demand.Both general markets and...
fragility, in the normal life cycle
Life cycle
Life cycle or lifecycle may refer to: * Biological life cycle* Enterprise life cycle* Life cycle assessment* New product development* Product lifecycle , various meanings* Project life cycle...
of an economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
, with speculative
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
investment bubbles endogenous
Endogeneity (economics)
In an econometric model, a parameter or variable is said to be endogenous when there is a correlation between the parameter or variable and the error term. Endogeneity can arise as a result of measurement error, autoregression with autocorrelated errors, simultaneity, omitted variables, and sample...
to financial markets. Minsky claimed that in prosper
Prosper
Prosper may refer to:In people:* Prosper de Mestre Sydney businessman fom 1818 to 1844* Prosper of Aquitaine, also known as Prosper Tiro, Christian writer and disciple of St Augustine* Prosper of Catenanuova, martyr, patron saint of Catenanuova...
ous times, when corporate cash flow
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis
Financial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
. As a result of such speculative borrowing bubbles, bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s and lenders tighten credit availability, even to companies that can afford loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s, and the economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
subsequently contracts.
This slow movement of the financial system from stability to fragility, followed by crisis, is something for which Minsky is best known, and the phrase "Minsky moment
Minsky moment
A Minsky moment is when over-indebted investors are forced to sell good assets to pay back their loans, causing sharp declines in financial markets and jumps in demand for cash. In any credit cycle or business cycle it is the point when investors begin having cash flow problems due to the spiraling...
" refers to this aspect of Minsky's academic work.
"He offered very good insights in the '60s and '70s when linkages between the financial markets and the economy were not as well understood as they are now," said Henry Kaufman
Henry Kaufman
Henry Kaufman is a Jewish American economist and financial consultant.Born in a small village named Wenings in Germany as son of a butscher...
, a Wall Street money manager and economist. "He showed us that financial markets could move frequently to excess. And he underscored the importance of the Federal Reserve as a lender of last resort
Lender of last resort
A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to...
."
Minsky's model of the credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
system, which he dubbed the "financial instability hypothesis" (FIH), incorporated many ideas already circulated by John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...
, Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
, Knut Wicksell
Knut Wicksell
Johan Gustaf Knut Wicksell was a leading Swedish economist of the Stockholm school. His economic contributions would influence both the Keynesian and Austrian schools of economic thought....
and Irving Fisher
Irving Fisher
Irving Fisher was an American economist, inventor, and health campaigner, and one of the earliest American neoclassical economists, though his later work on debt deflation often regarded as belonging instead to the Post-Keynesian school.Fisher made important contributions to utility theory and...
. "A fundamental characteristic of our economy," Minsky wrote in 1974, "is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
s."
Disagreeing with many mainstream economists of the day, he argued that these swings, and the booms and busts that can accompany them, are inevitable in a so-called free market economy
Market economy
A market economy is an economy in which the prices of goods and services are determined in a free price system. This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed...
– unless government steps in to control them, through regulation
Financial regulation
Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system...
, central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
action and other tools. Such mechanisms did in fact come into existence in response to crises such as the Panic of 1907
Panic of 1907
The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis that occurred in the United States when the New York Stock Exchange fell almost 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on...
and the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
. Minsky opposed the deregulation
Deregulation
Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
that characterized the 1980s.
It was at the University of California at Berkeley that seminars attended by Bank of America
Bank of America
Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina...
executives helped him to develop his theories about lending and economic activity, views he laid out in two books, John Maynard Keynes (1975), a classic study of the economist and his contributions, and Stabilizing an Unstable Economy (1986), and more than a hundred professional articles.
Further developments
Minsky's theories have enjoyed some popularity, but have had little influence in mainstream economicsMainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
or in central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
policy.
Minsky stated his theories verbally, and did not build mathematical models based on them. Consequently, his theories have not been incorporated into mainstream economic models, which do not include private debt as a factor. The post-Keynesian economist Steve Keen
Steve Keen
Steve Keen is a Professor in economics and finance at the University of Western Sydney. He classes himself as a post-Keynesian, criticizing both modern neoclassical economics and Marxian economics as inconsistent, unscientific and empirically unsupported...
has recently developed models of endogenous economic crises based on Minsky's theories, but they are currently at the research stage and do not enjoy widespread use.
Minsky's theories, which emphasize the macroeconomic dangers of speculative bubbles
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...
in asset prices, have also not been incorporated into central bank policy. However, in the wake of the financial crisis of 2007–2010 there has been increased interest in policy implications of his theories, with some central bankers advocating that central bank policy include a Minsky factor.
Understanding Minsky's financial instability hypothesis
Hyman Minsky's theories about debt accumulation received revived attention in the media during the subprime mortgage crisisSubprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
of the late 2000s.
Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
borrowers, speculative
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
borrowers, and Ponzi borrowers.
The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments. For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi
Charles Ponzi
Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi, , commonly known as Charles Ponzi, was a businessman and con artist in the U.S. and Canada. Born in Italy, he became known as a swindler in North America for his money making scheme. His aliases include Charles Ponei, Charles P. Bianchi, Carl and Carlo...
, see also Ponzi scheme
Ponzi scheme
A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from any actual profit earned by the individual or organization running the operation...
) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat. Because of the unlikelihood of most investments' capital gains being enough to pay interest and principal, much of this type of finance is fraudulent.
If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes
Dominoes
Dominoes generally refers to the collective gaming pieces making up a domino set or to the subcategory of tile games played with domino pieces. In the area of mathematical tilings and polyominoes, the word domino often refers to any rectangle formed from joining two congruent squares edge to edge...
, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.
Applying the hypothesis to the subprime mortgage crisis
Economist Paul McCulleyPaul McCulley
Paul Allen McCulley is a former managing director at PIMCO. He coined the terms Minsky moment and Shadow banking system which became famous during the Financial crisis of 2007-2009....
described how Minsky's hypothesis translates to the subprime mortgage crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
. McCulley illustrated the three types of borrowing categories using an analogy from the mortgage market: a hedge borrower would have a traditional mortgage loan
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
and is paying back both the principal and interest; the speculative borrower would have an interest-only loan
Interest-only loan
An interest-only loan is a loan in which, for a set term, the borrower pays only the interest on the principal balance, with the principal balance unchanged...
, meaning they are paying back only the interest and must refinance later to pay back the principal; and the ponzi borrower would have a negative amortization
Negative amortization
In finance, negative amortization, also known as NegAm, deferred interest or graduated payment mortgage, occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases...
loan, meaning the payments do not cover the interest amount and the principal is actually increasing. Lenders only provided funds to ponzi borrowers due to a belief that housing values would continue to increase.
McCulley writes that the progression through Minsky's three borrowing stages was evident as the credit and housing bubbles built through approximately August 2007. Demand for housing was both a cause and effect of the rapidly-expanding shadow banking system
Shadow banking system
The shadow banking system is the infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and Structured investment vehicles...
, which helped fund the shift to more lending of the speculative and ponzi types, through ever-riskier mortgage loans at higher levels of leverage. This helped drive the housing bubble, as the availability of credit encouraged higher home prices. Since the bubble burst, we are seeing the progression in reverse, as businesses de-leverage, lending standards are raised and the share of borrowers in the three stages shifts back towards the hedge borrower.
McCulley also points out that human nature is inherently pro-cyclical, meaning, in Minsky's words, that "from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes, the economic system's reactions to a movement of the economy amplify the movement – inflation feeds upon inflation and debt-deflation feeds upon debt deflation." In other words, people are momentum
Momentum (technical analysis)
Momentum and rate of change are simple technical analysis indicators showing the difference between today's closing price and the close N days ago. Momentum is the absolute difference in stock, commodity:...
investors by nature, not value investors. People naturally take actions that expand the high and low points of cycles. One implication for policymakers and regulators is the implementation of counter-cyclical policies, such as contingent capital requirements for banks that increase during boom periods and are reduced during busts.
Views on John Maynard Keynes
Minsky, along with Donald MarkwellDonald Markwell
For the Montgomery, Alabama, talk radio personality, Don Markwell, see Don Markwell Professor Donald John 'Don' Markwell is an Australian social scientist and college president...
, and unlike most economists, took seriously Keynes' idea that economics could be conducive to a more peaceful world. Minsky, elucidating a personal interpretation in his book John Maynard Keynes (1975), claimed that the adoption of the neoclassical synthesis
Neoclassical synthesis
Neoclassical synthesis is a postwar academic movement in economics that attempts to absorb the macroeconomic thought of John Maynard Keynes into the thought of neoclassical economics...
had diluted Keynes’ message. Notably, he placed a greater focus on the notion of Knightian uncertainty
Knightian uncertainty
In economics, Knightian uncertainty is risk that is immeasurable, not possible to calculate.Knightian uncertainty is named after University of Chicago economist Frank Knight , who distinguished risk and uncertainty in his work Risk, Uncertainty, and Profit:- Common-cause and special-cause :The...
, which "does not deal with risks that are insurable or analogous to gambling risks".
Selected publications
- (1982) Can "It" Happen Again?. ISBN 978-0-87-332213-3
- (2008) [1st. Pub. 1975]. John Maynard Keynes. McGraw-Hill Professional. ISBN 978-0-07-159301-4
- (2008) [1st. Pub. 1986]. Stabilizing an Unstable Economy. McGraw-Hill Professional. ISBN 978-0-07-159299-4
- "The breakdown of the 1960s policy synthesis". Telos 50 (Winter 1981-82). New York: Telos Press.
Further reading
- Robert Barbera (2009). The Cost of Capitalism. McGraw-Hill Professional. ISBN 978-0-07-162844-0
External links
- Hyman Philip Minsky, Distinguished Scholar, The Levy Economics Institute of Bard College, Blithewood, Bard College, Annandale-on-Hudson, New York
- Major Works of and Resource on Minsky
- Marc Schnyder: Die Hypothese finanzieller Instabilität von Hyman P. Minsky Thesis, University of Fribourg, Switzerland, (German)
- In Time of Tumult, Obscure Economist Gains Currency
- New Yorker article on Minsky
- Securitization by Hyman Minsky
- Why capitalism fails
- Optimistic for a more humane economy
- The Fed discovers Hyman Minsky, The Economist, Jan 2010
- The Limits of Minsky’s Financial Instability Hypothesis as an Explanation of the Crisis by Thomas I. Palley