Sunday, February 03, 2008

Hyman Minsky: Man of the Moment

There has been quite a bit of talk about Hyman Minsky recently, and for good reason. In particular, this week's New Yorker leads off with an article by John Cassidy about Hyman Minsky.

Minsky was a Post Keynesian economist who I read years ago. I think in particular of his book John Maynard Keynes, which I thought quite good. I do not recall the five business-cycle stages John Cassidy mentions (displacement, boom, euphoria, profit taking, and panic). The elements I do recall lie elsewhere. I'm currently reading a couple of articles to help my recollection.

As I recall, Minsky emphasizes that Keynes' General Theory was set in a business cycle context. He thinks this context important in understanding Keynes' idea of an unemployment equilibrium. Minsky also points out the tendency under capitalism to continually evolve new financial instruments and new markets for trading in second-hand debt. (Thus, a regulatory regime will also need to evolve if a recurrence of debt-deflation is to be avoided.) In a sense, Minsky's view is that the supply of money is endogenous and non-neutral in the long run.

Minsky makes a tripartite distinction among types of finance:
  • Hedge Finance: The returns to an investment both cover interest charges and allow the principal to be paid off.
  • Speculative Finance: The returns cover interest charges, but the principal must be rolled over when it comes due.
  • Ponzi finance: The returns do not even cover interest charges and one must take on a growing burden of debt.
Businesses take on finance for leverage.

As memories of the last downturn fade, pressure grows to become more highly leveraged. Speculative and ponzi finance grow at the expense of hedge finance. Notice that unexpected events can convert hedge finance to speculative finance and speculative finance to ponzi finance. The returns to an investment might not be as expected. Perhaps an institution from which you were expecting a cash flow goes bankrupt. So if returns were previously expected to cover more than interest charges, one might now find that returns can only be expected to cover interest charges. Or perhaps the interest rate is higher than expected when the principal comes due. A speculator can only roll over the principal in the hope that later refinancing will improve his situation. At any rate, the financial system is endogenously unstable.

Do these observations speak to the current mortage problems and their potential for affecting the broader economy?

On-Line References

2 comments:

Gabriel Mihalache said...

Well, that's certainly one story out of many. How could I tell these are actually the mechanisms at work?

Beyond that, governmental action is endogenously unstable too.

How exactly does it follow that, assuming the financial system is as described here, public policy can do something about it, if policy makers are anything other than all-seeing, all-powerful aliens?

dsquared said...

You don't have to be an all-seeing, all-powerful alien to recognise excessive use of leverage when you see it. It is not as if the current real estate bubble was not widely predicted, along with its consequences. The current situation is actually much less forgiveable than the dot com boom, because in the 1990s/early 00s, there was actually a new productive technology and genuine uncertainty about productivity. But just bidding up the prices of land (a zero-sum game) and compromising underwriting standards to do so (and effectively engineering a public subsidy through the to-big-to-fail doctrine) are exactly the sorts of things that competent regulators ought to be in the business of doing something about.