If Hyman Minsky had not died too soon, he would be the man of the hour. A Harvard-trained economist who taught at the University of California-Berkeley and Washington University in St. Louis, Minsky argued that financial market crises like the one we are in right now are inherently part of a market-based system.
Or as he put it, “A fundamental characteristic of our economy is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycles.”
If he had lived into his 90s, like Milton Friedman, Paul Samuelson or John Kenneth Galbraith, he would have had his day in the sun. Unfortunately, he died in 1996 at age 77.
Minsky’s idea that speculative investment bubbles and resulting crashes were part of the system ran counter to prevailing wisdom. Most economists saw markets always tending toward some equilibrium unless disturbed by “exogenous” shocks, those from outside the system. Milton Friedman and Alan Greenspan are just two of the myriad economists who thought along those lines. So during his life, Minsky remained on the fringe of economics. But his predictions are more insightful than anyone else’s in explaining the mess we are in now.
Ironically, what Greenspan famously described as “irrational exuberance” is for Minsky precisely what drives the cycle. When times are good, investors take on risk. They see their investments as profitable and borrow to increase their stakes.
Such optimism helps propel the economy forward, inflating a financial bubble. Investors borrow more and take on more risk and leverage.
But at some point, the cash these investments generate no longer suffices to service the debt taken on by investors. Lenders call in their loans. Investors have to dump their assets into a falling market to come up with the cash, and the bubble collapses.
At some point, the need for cash becomes so extreme that investors have to liquidate even very safe investments. That is a “Minsky moment,” in the words of his followers. Some think we experienced such a moment in mid-October.
Others think it lies somewhere in the near future. Time will tell.
In any case, Minsky did not favor deregulation of financial markets. Without prudent regulation and action by the central bank, the harm from inevitable financial market swings can be extreme.
Minsky saw that in the 1929 stock market crash and the Great Depression.
He would probably see it now. Unfortunately, he is not around to advise us in person, but his books and scholarly papers are suddenly being scoured for insights.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.