Man of the Moment

Hyman Minsky and the Groundhog Day of Speculative Finance

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There is no final solution to the problems of organizing economic life.

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Anyone living through the cascading crises of the post-2000 era needs little convincing of Hyman Minsky’s theory that “stability causes instability.” It is now the eerie calm, the “sound unheard,” that puts modern investors most on edge. Minsky’s theory has an important, often overlooked corollary though: Our destiny to repeat the cycle of crises and bailouts under modern speculative finance. Major crises have, for the most part, been federally short-stopped. Investors have been trained to expect limited pain before the speedy application of either fiscal or monetary analgesic. This is of limited comfort, not unlike chasing a big night out with hair-of-the-dog, the reckoning has merely been delayed not altogether avoided. Economist Joseph Schumpeter wrote regarding the Great Depression:

Any revival which is merely due to artificial stimulus leaves part of the work of depressions un-done and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another crisis ahead.

Minsky’s big idea predated even Minsky himself in many ways. As we recounted here, Samuel Taylor Coleridge identified the distorting impacts of market serenity in one of his Lay Sermons:

…there have occurred at intervals of about 12 or 13 years each, certain periodical Revolutions of Credit…for a short time this Icarian Credit, or rather illegitimate offspring of CONFIDENCE…seems to lie stunned by the fall…Alarm and suspicion gradually diminish into a judicious circumspectness; but little by little, circumspection gives way to the desire and emulous ambition of doing business;  till Impatience and Incaution on the one side, tempting and encouraging headlong Adventure, Want of principle, and Confederacies of false credit on the other, the movements of Trade become yearly gayer and giddier, and end at length in a vortex of hopes and hazards, of blinding passions and blind practices

A succinct and digestible version of Minsky’s theory of financial instability can be found in a 1986 monograph prepared for The Bank Analyst Conference titled “Stabilizing an Unstable Economy”

An immediate corollary of the endogenous instability of capitalism is that totally free market modern capitalist economy is economically and politically impossible, for in such an economy financial disasters and economic depressions will frequently occur.

Minsky is right; prior to World War II, crises and panics were relatively frequent. Keynesianism ushered in an era of monetary reforms that aimed to smooth the rough ride of capitalism. When he wrote to the bank analyst, more than 40 years had passed without a serious depression. The inherent shortcoming of financial regulation and then reactionary intervention distorts the appropriate market responses to distress. Instead of a conservative retrenchment, there is an implicit assumption that policymakers’ limited tolerance for recession means that forthcoming liquidity will again stoke risk assets.

To the extent that the structural reforms and regulations were effective, they constrained activities that were attractive to at least some players; some profit opportunities were blocked. Such blocked profit opportunities induce market participants to innovate, to develop institutions and instruments that evade or avoid the constraint. Regulatory systems tend to break down, especially after a run of good times during which the disasters, which the regulatory system was designed to prevent or contain, do not occur.

Modern examples abound of the kind of evasion Minsky references. Whether it’s traditional financial institutions becoming “crypto-friendly” or more exotic financial creations like the spectacular rise and fall of Greensill Capital, global finance lacks no creativity when it comes to designing boxes to hold and distribute novel risks that appear staid at first glance. When these risks inevitably bubble to the surface, policymakers, largely academic economists, are ill-equipped to handle episodic crises precisely because their understanding of the world doesn’t include irrationality. Mainstream economics relies on an equilibrium assumption that simply does not correspond with the real world.

Mainstream economics does not help because systemic situations that force interventions...are not possible system states within the standard theory.

It isn’t merely that stability breeds instability, it's that when instability is finally loosed, decision-makers act mainly out of a fear of not acting.

A world is ‘irrational’ to decision-makers when the theory they accept does not explain what happens and therefore does not offer policymakers reasonably argued scenarios about the consequences of different actions.

Minsky, a father of post-Keynesianism, applauded and supported the role of governments in containing financial crises. Yet, he believed their tools were lacking and their reliance on neoclassical models left them reeling when the proverbial dam finally broke. Nonetheless, he maintained that the combination of an implicit lender-of-last-resort in the form of the Fed and the willingness for deficit spending to maintain profits had successfully kept major depressions at bay. Minsky understood the important role of faith in the upward trajectory of modern market economies.

No matter how exalted a bank may have been, we all know that if assets were marked-to-market the net worth of many of the giants of international banking would disappear. Nevertheless, these banks are able to sell their liabilities in financial markets because the buyers believe that they will be protected against losses by the central bank.

Minsky further clarified, presciently, that “‘depositor’ will be broadly defined when a giant bank fails.”

Groundhog Day

The financial Groundhog Day we seem to exist in—the cycle of speculative froth, crises, then bailout is treated as an aberration from business-as-usual by the media and traditional academics. Our crises are viewed as just accidents on the road to the Valhalla of market efficiency. However, modern economists like Martijn Konings argue that Minsky’s core idea was that these episodes are endogenous to the system¹. Since value is realized in an unknowable future; the nature of all financial value is to some degree speculative and when the collective consciousness begins to adjust those values to fundamentals “the Minsky Moment” takes hold.

Minsky thought of debt and speculation not as pathological features of an otherwise robust capitalism based on the production of real things. Instead, he viewed the tapestry of debt and credit as the very stuff of capitalist life.

Minsky did not see a solution to the market pathos of too-big-to-fail and perpetual bailout². In some ways, approaching the precipe of collapse only strengthens our conviction in capitalist finance. Konings:

Never do we have more certainty about the need to maintain capitalism’s key institutions than at times when the banks seem about to fail and we face genuine uncertainty.

These periods invite moralizing from across the political spectrum. Portions of the commentariat decry the bailout of the elite at the expense of the working class while others point to the original liquidity-driven wealth creation as borrowing unsustainably from the future. Most critically that “the need for bank bailouts as manifesting the essential incoherence of neoliberal finance, its lack of solid foundations and the irrationality of speculation.” But Konings, cutting to the heart of Minsky’s philosophy, has a bleaker conclusion:

The way deepening inequality and the growth of asset values continue to feed off each other is troubling for any number of reasons, but there is nothing inherently ‘unsustainable’ about it – the process does not have a natural or objective limit.

Confidence Trick

As our current banking crisis unfolds, Martin Sandbu at the Financial Times asks “Have we then learnt nothing?” The response to the failure of Silicon Valley Bank and subsequent ripples have largely tracked what Minsky called “misadventure” arising from crisis response. In their desire to do something quickly, policymakers have once again changed the theoretically zero-sum game of capitalism to one with undefined, or rather socialized, winners and losers. Sandbu:

The authorities are clearly hoping they can calm markets down instead — the very definition of a confidence trick. But if it doesn’t work, the pain will be greater. Again, it’s short-sightedness passing for responsible pragmatism.

Matthew Zeitlin @MattZeitlin

amazingly clear and succint (273 words!) description of what, generally, a financial crisis is ft.com/content/33c0d6…

Now, as the crisis goes beyond our own borders to Credit Suisse and potentially further, another fear of Minsky’s is playing out: That increased complexity and globalization of finance renders further obsolete the already lacking understanding of global policymakers. Minsky’s views were shaped by “having a foot in Wall Street.”³ Minsky approached theoretical questions with an eye toward the latest trends and practices of high finance and felt they were critical to understanding how the world works.

Despite his pragmatism, Minsky is really only ever given serious regard after a speculative bubble begins to burst. As James Grant famously quipped, “Progress is cumulative in science and engineering, but cyclical in finance.”

1. The Time of Finance (lareviewofbooks.org)

“The structure of the capitalist economy is a temporal one — not just in the trivial sense that things take place in time and are therefore subject to change, but in the more profound sense that time is an active force and that it therefore makes no sense to analyze processes of change as if they are driving toward a neutral state where things are organized according to their true value or purpose. The logic of credit and debt cannot be seen as something that takes place while more fundamental processes work themselves out. For Keynes, the “meantime” mattered because, as he famously quipped, “we are all dead in the long run.” Minsky did not have much use for the idea of such an independently given long run: in the economic game of capitalism, some survive and others die, some thrive and others languish. In that sense, there really only is the meantime — all time was borrowed.”

2. The Unknown Hyman Minsky - Progress in Political Economy (PPE) (ppesydney.net)

“The American state was never going to sit idly by as the financial system returned to dynamics of boom and bust: when instability took the form of systemic threats, authorities would bail out the institutions that had overextended themselves. Of course, Volcker would not have been able to predict the specific features of the too-big-to-fail regime as it emerged during the 1980s and evolved subsequently; but the very point of the neoliberal turn in financial management that he had overseen was to create a context where risk could be socialized in ways that were more selective and therefore did not entail generalized inflation.”

3. Why Minsky Matters: An Introduction to the Work of a Maverick Economist - Introduction (princeton.edu)