Hyman Minsky
Hyman Philip Minsky was an American economist and economy professor at Washington University in St. Louis. A distinguished scholar at the Levy Economics Institute of Bard College, his research was intent on providing explanations to the characteristics of financial crises, which he attributed to swings in a potentially fragile financial system.
Minsky is often described as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets, opposed some of the financial deregulation of the 1980s, stressed the importance of the Federal Reserve as a lender of last resort and argued against the over-accumulation of private debt in the financial markets.
Minsky's economic theories were largely ignored for decades, until the subprime mortgage crisis of 2008 caused a renewed interest in them.
Education
A native of Chicago, Illinois, Minsky was born into a Jewish family of Menshevik 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 1937, Minsky graduated from George Washington High School in New York City. 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.Career
Minsky taught at Brown University 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. He was a consultant to the Commission on Money and Credit while at Berkeley.Financial theory
Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculative investment bubbles endogenous to financial markets. Minsky stated that in prosperous 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, banks and lenders tighten credit availability, even to companies that can afford loans, 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", 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 cycles."
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, 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, a classic study of the economist and his contributions, and Stabilizing an Unstable Economy, and more than a hundred professional articles.
Further developments
Minsky's theories have enjoyed some popularity, but have had little influence in mainstream economics or in central bank policy.Minsky stated his theories verbally, and did not build mathematical models based on them. Minsky preferred to use interlocking balance sheets rather than mathematical equations to model economies: "The alternative to beginning one's theorizing about capitalist economies by positing utility functions over the reals and production functions with something labeled K is to begin with the interlocking balance sheets of the economy." Consequently, his theories have not been incorporated into mainstream economic models, which do not include private debt as a factor.
Minsky's theories, which emphasize the macroeconomic dangers of speculative bubbles in asset prices, have also not been incorporated into central bank policy. However, after the 2008 financial crisis, there has been increased interest in policy implications of his theories, with some central bankers advocating that central bank policy include a Minsky factor.
Minsky's theories and the subprime mortgage crisis
Minsky's financial instability-hypothesis
Hyman Minsky's theories about debt accumulation received revived attention in the media during the subprime mortgage crisis of the first decade of this century. The New Yorker has labelled it "the Minsky Moment".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 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" 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.
These 3 types of borrowers manifest into a 3-phased system:
- Hedge Phase: This phase occurs right after a financial crisis and after recovery, during a point at which banks and borrowers are overly cautious. This causes loans to be minimal ensuring that the borrower can afford to repay both the initial principal and the interest. Thus, the economy is most likely seeking equilibrium and virtually self-containing. This is the "not too hot not too cold" Goldilocks phase of debt accumulation.
- Speculative Phase: The Speculative period emerges as confidence in the banking system is slowly renewed. This confidence brings about complacency that good market conditions will continue. Rather than issue loans to borrowers that can pay both principal and interest, loans are issued where the borrower can only afford to pay the interest; the principal will be repaid by refinancing. This begins the decline to instability.
- Ponzi Phase: As confidence continues to grow in the banking system and banks continue to believe that asset prices will continue to rise, the third stage in the cycle, the Ponzi stage, begins. In this stage the borrower can neither afford to pay the principal nor the interest on the loans which are issued by banks leading to foreclosures and vast debt failures.
Application to the subprime mortgage crisis
Economist Paul McCulley 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.