r e s e a rc h o n m o n e y a n d f i n a n c e · of the birth of john maynard keynes and joseph...
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R E S E A R C H O N M O N E Y A N D F I N A N C E
Discussion Paper no 12
A Minsky Perspective on the Global Recession of 2009
Charles J WhalenUtica College, Cornell University School of Industrial and Labor Relations
1 July 2009
Research on Money and Finance Discussion Papers
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Abstract
AstheU.S.creditcrunchof2007evolvedintoaglobalrecessioninlate2008 and early 2009, the economic ideas of the late HymanMinskyreceived increasing attention on both sides of the Atlantic Ocean.However, few observers seem to appreciate that about the last dozenyearsofMinsky’slifeweredevoted largelytosynthesizinghisfinancial‐instabilityhypothesis(theinfluenceofKeynes)andhisunderstandingoflong‐termcapitalist development(the influenceofSchumpeter). Tofillthatgap,thisessayoffersaMinskyperspective ontheglobalrecessionof 2009by drawing on the insightsMinsky gained from Keynes andSchumpeter. While the Keynesian and Schumpeterian dimensions ofMinsky’s viewpoint are intertwined intherealworld, thispresentationhighlights the cyclical and structural aspects of the current crisisseparately. After examining the nature and causes of the globaldownturn through those two lenses, Minsky’s policy proposals arecomparedwithstepstakenbytheU.S.governmentthroughApril2009.
1.Introduction OnAugust18, 2007,a front‐pagestory inTheWallStreet Journalhighlighted theideasof
economist Hyman Minsky. With the U.S. economy in the midst of a worsening credit
crunch, reporterJustinLahartobservedthatalthoughMinskydied in1996,hisviewswere‘reverberating from New York to Hong Kong as economists and traders are trying to
understandwhat’shappeninginthemarkets’(Lahart2007).
Since2007, attention toMinsky’sideashas increased as global economic conditionshave
deteriorated(see,forexample,Cassidy2008;Pollin2008;and‘Minsky’sMoment’2009).As
aneconomistwho haslongappreciatedMinsky’sinsights,I am happyto seethisflurryofinterest.YetIfearthatmanyobservershavemissedthefullsignificanceofhiscontributions.
ManyofthosenowontheMinskybandwagontreathisideasasrelevanttounderstandingasingleeconomic event.Market analysts andtraders even referto that event asa ‘Minsky
moment,’ which arrives ‘when over‐indebted investors are forced to sell even their solid
investments tomakegoodontheir loans’ (Lahart2007). Ifthetroublewere tobecomesowidespreadthatitthreatenedthebankingsystematthenationalorinternationallevel,then
somewouldreplacetheword‘moment’with‘meltdown’(Magnus2008).However,thefocusisstillonasingleincident,notontheevolutionarypathofeconomicactivity.
Others exposedtoMinsky’s ideasacknowledge that hisworkwas grounded in adynamic
conception of theeconomy. Formost in this group, though,Minsky’splace ineconomicsrestsonwhathecalledthe“financial‐instabilityhypothesis.’AccordingtoMinsky,capitalist
financial systems tend to cycle endogenously from a conservative state of affairs calledhedgefinancing,toamoreriskyformcalledspeculativefinancing,toanunsustainableform
calledPonzifinancing,andthenbacktohedgefinancingforanotherround.Thispatternof
economicactivitytendstogenerateaseriesofboomsandrecessions,andtheseverityofthelatter depends largely on the effectiveness of government regulation and stabilization
policies(Minsky1982;1992a).
AfullappreciationofMinsky’sinsights,however,mustrecognizethataboutthelastdozen
yearsofhislifeweredevotedlargelytosynthesizingthefinancial‐instabilityhypothesisand
anunderstandingof long‐term capitalistdevelopment.Indeed, in an essaywritten forthehundredth anniversary of the birth of John Maynard Keynes and Joseph Schumpeter,
Minskywrote: ‘The task confronting economics todaymay becharacterized as a need tointegrate Schumpeter’s vision of a resilient intertemporal capitalist process with Keynes’s
hardinsightsinto thefragilityintroducedinto thecapitalistaccumulationprocessbysome
inescapable properties of capitalist financial structures’ (Minsky 1986a, 121). A keyconclusionofMinsky’spursuitofsuchasynthesisisthatalthoughthe ‘basicpath’ofreal‐
worldcapitalism iscyclical (Minsky1975,9), the ‘money‐managercapitalism’ characteristic
ofrecentdecadesdifferssubstantiallyfromthe‘managerialcapitalism’foundintheUnitedStatesimmediatelyafterWorldWarII(Minsky1990a;1993a).Asuccessfuleconomicpolicy
forthepresenteramustbebuiltuponrecognitionoftheinstitutionalfeaturesofthisstage
ofcapitalistdevelopment(MinskyandWhalen1996‐1997).
ThischapteroffersaMinskyperspectiveontheglobalrecessionof2009bydrawingonthe
insights Minsky gained from both Keynes and Schumpeter. While the Keynesian andSchumpeterian dimensions ofMinsky’s viewpoint are intertwined in the real world, the
cyclicalandstructuralaspectsofthecurrentcrisisarehighlightedseparatelyintheanalysis
thatfollows.Afterexaminingthenatureandcausesoftheglobaldownturnfromthosetwolenses,Minsky’spolicyproposalsarecomparedwith recent policy steps takenbytheU.S.
government.
2.CyclicalDynamics
Minsky’s financial‐instability hypothesis can be seen as an alternative to the ‘efficient‐market hypothesis’ of conventional economics. According to that conventional view,
investors,lendersandotherfinancial‐marketparticipantsarenot,asagroup,predisposedtooverconfidence or other biases (Shefrin 2000, 4). In contrast, the financial‐instability
hypothesistreatsoverconfidenceandpanicsasregularfeaturesoftheeconomiclandscape.
MinskytracesthisaspectofhisperspectivetoKeynes,especiallytothelatter’s1937articleinTheQuarterly Journal of Economics, ‘TheGeneral Theory ofEmployment’ (Minsky 1975,
64‐67; Keynes 1937). In that essay, Keynes describes his departure from the mainstreameconomicsofhistime,whichhecalled‘classical economictheory,’ asthedeparturefroma
focusonlong‐periodequilibrium(Keynes1937,213‐214).Behindboththeclassicaltheoryof
Keynes’s timeand the efficient‐market hypothesis of our own is an assumption that thefuture can be treated as a matter involving risk (reducible to the calculation of
probabilities), not uncertainty. Keynes, however, dismisses this substitution of risk foruncertaintyinthecaseofmosteconomicanalyses:
Thewholeobjectoftheaccumulationofwealth isto produceresults,orpotential
results,at acomparativelydistant, andsometimes at an indefinitelydistant,date.Thusthe fact thatourknowledgeofthefuture isfluctuating,vagueanduncertain
renderswealthapeculiarlyunsuitablesubjectforthemethodsofclassicaleconomictheory.Thistheorymightworkverywell inaworldinwhicheconomicgoodswere
necessarily consumed within a short interval of their being produced. But it
requires,Isuggest,considerableamendmentifitistobeappliedtoaworldinwhichthe accumulation of wealth for an indefinitely postponed future is an important
factor; andthegreatertheproportionatepart playedbysuchwealth‐accumulationthemoreessentialdoessuchamendmentbecome(Keynes1937,213).
According to Minsky, the financial structure of our economy becomes more and more
fragile overa periodofprosperity. In theearly stages ofprosperity, enterprises in highlyprofitablesegmentsoftheeconomyarerewardedfortakingonincreasingamountsofdebt.
Andtheirsuccessencouragesotherfirmstoengageinsimilarbehavior.
Thispatternwascertainlyevident inthehigh‐techsectorduring thelate1990sandinthe
housing sector during the early‐ and mid‐2000s. In fact, construction companies and
contractorswerenottheonlyonestakingonmoredebtinthe2000s.Homebuyerswerealsotakingonmoredebtasthehousingmarketbeganheatingup,inpartbecauseinterestrates
werelowandthestockmarkethadbecomelessattractiveinthewakeofthedot‐comboomand bust. While it had long been customary for U.S. homebuyers to make a 20‐percent
downpaymentonahome,42percentoffirst‐timehomepurchasersand13percentofbuyers
whowerenotfirst‐timepurchasersputnomoneydowntoacquirehomesinthemid‐2000s(Baker2009a;Max2005;Irwin2005).1
In retrospect, it seems that enterprisesandhomebuyersshouldhaveresisted the impulsetowardincreasingindebtedness,buttheincentivesatthetimewerejusttoogreat.AsGary
DymskiandRobertPollinexplainina1992essay,nobodyinarobustsectoroftheeconomy
wantstobeleftbehindduetounderinvestment:
EvenifmarketparticipantsdidhavefullknowledgeoftheMinskymodel,andwere
awarethatfinancialcriseswilloccuratsomepoint,thatwouldstillnotenablethemto predict when the financial crisis will occur. In the meantime, aggressive firm
managers and bank loan officers will be rewarded for pursuing profitable
opportunities and gaining competitive advantages. Cautious managers, operatingfromtheunderstandingthatboomconditionswillendatsomeuncertainpoint,will
be penalized when their more aggressive competitors surpass their short‐runperformance(DymskiandPollin1992,45).2
As the preceding quote indicates, lenders as well asborrowers fuel the tendency toward
greater indebtedness in an expansion. The same climate of expectations that encouragesborrowerstoacquiremoreriskyfinancialliabilitystructuresalsoeaseslenders’worriesthat
new loans might go unpaid (Minsky 1975). Moreover, it is not just that borrowing andlending expand in the boom. There is also financial innovation. In fact, in a 1992 essay,
Minskywrotethatbankersandotherfinancial intermediariesare ‘merchantsofdebt,who
strive to innovate with regard to both the assets they acquire and the liabilities theymarket’(Minsky1992a,6).
Theboomcannotcontinueforever,however;weeventuallyarriveatwhatsomehavecalledthe‘Minskymoment’(Lahart2007,1).Inotherwords,iteventuallybecomesclearthatsome
borrowers have become overextended and need to sell assets (or secure a government
bailout)tomaketheirpayments.Inthecurrentcrisis,earlyhigh‐profilecases involvedthemortgagebrokerCountrywide,theBritishbankNorthernRock,andtwohedgefundsrunby
BearStearns (Stempel 2007;Reckard,Douglass andPetruno 2007; LarsenandGiles 2007;Mildenberg2008;Foley2007).3
Then the problem spreads. Since bankers and investors hold subjective views about
acceptable debt levels, once a shortfall of cash and a forced selling ofassetsmaterializessomewhereintheeconomy,it canleadtoawidespreadreassessmentofhowmuchdebtor
lending isappropriate.Moreover, thebuildupcangoonforyears,butwhenanythinggoeswrongtherevaluationcanbesudden(Minsky1982,67).
Whenbanksdecidetoreinintheirlending,wefindourselvesinacreditcrunch.Itiseasyto
think of the present economic crisis as something that beganwith theworldwide stock‐market downturn in the autumn of 2008. In fact, though, the difficulties of 2008 were
preceded by a credit crunch that began in the summer of 2007, and signs of trouble—traceableinlargepartto the‘subprime’mortgagemarket—wereevidentasearlyasMarch
2007(Magnus2007;Foley2007;‘Timeline’2009).
Onceacreditcrunchemerges,financialdifficultiesarenolongerconfinedtoonesector.Infact,acrunchthreatensnotonlybusinessinvestment,butalsohouseholdspending.Thismeansthat
whenasectoralbubblebursts—inthehigh‐techsectornearlyadecadeagoorinthehousingsectormorerecently—thecollapsethreatenstotriggeraneconomy‐widerecession.
AndthatsortofrecessioniswhattheUnitedStatesandmuchoftheworldnowexperiences.
Moreover, it isprettyclearthesituationhasgonebeyondaMinsky‘moment’ andismoreakintoaneconomic‘meltdown,’atleastwithrespecttoU.S.housing,banking,andstocks.
TheDow Jones industrial average, for example, fell 37 percent between April 1, 2007 andApril1,2009(YahooFinance2009).Meanwhile, theU.S.unemploymentraterosefrom 4.4
percentinMarch2007to8.5percentinMarch2009(thelatestmonthlydataavailableasof
thiswriting),andiswidelyexpected tocontinuerising through2009(U.S.DepartmentofLabor2009;‘Obama’seconomicaideseesrisingU.S.unemployment’2009).
3.StructuralEvolution
In a pair of articles designed to integrate key contributions of Keynes and Schumpeter,
Minsky mentions that Keynes and institutionalist Wesley C. Mitchell had a commonperspective on business cycles (Minsky 1993a; 1990a). Bringing Mitchell into the picture
helpsunderscorethesortofsynthesistowardwhichMinskywasaiming:Mitchellhadlongagowrittenthat ‘eachnewcyclepresentsidiosyncrasies.Businesshistoryrepeatsitself,but
alwayswithadifference’(Mitchell 1941,ix). Inthe1990s,MinskystillbelievedthattheU.S.
economymoves along a cyclical path, but he also believed that the system had recentlyentered a new stage of capitalist development. Themanagerial era that matured in the
immediate aftermath of World War II had, during the 1980s, given way to a stagecharacterized by emergence of money managers as the nation’s dominant economic
decision‐makers(Minsky1990a;1993a;1996;seealsoWhalen2001and2002).
WhileKeynesofferedinsightsinto cyclical fluctuations,Schumpeter(Minsky’sdissertationadvisor at Harvarduntil the relationshipwas cut short by Schumpeter’s untimely death)
providedMinskywithinsightsinto structuraleconomicevolutionoveraseriesofcycles.Infact,MinskyunderscoredanaspectofSchumpeterian‘creativedestruction’ that fewothers
recognized: ‘Nowhere are evolution, change and Schumpeterian entrepreneurship more
evident than inbanking andfinanceandnowhere isthedriveforprofitsmoreclearlythefactormaking for change’ (Minsky1993a, 106).Thus, fourinstitutional featuresofmoney‐
managercapitalismemergetoplayaroleinexplainingtheeconomicdifficultiesofthepastfewyears.Theoriginofthecurrentglobal crisiscanbetracedinlargepartto thefollowing
financial‐sector innovations: unconventional mortgages, securitization, the rise of hedge
funds,andtheglobalizationoffinance.
At the heart of the current financial crisis are home mortgages that deviate from the
traditional U.S. home‐loan arrangement, which involved a long‐term loan on fixed‐rateterms. Many of these unconventional—some have even called them ‘exotic’—mortgages
haveadjustableinterestratesand/orpaymentsthatballoonovertime.Federal lawallowed
banks to issue adjustable‐rate mortgages since 1982, but their use and complexity haveexplodedinthepastdecade.Forexample,industryexpertsestimatethatavariantcalledthe
‘optionadjustable ratemortgage’ (optionARM),which offers a low ‘teaser’ rate and laterresets so thatminimum payments skyrocket, accounted forabout 0.5 percent of all U.S.
mortgages written in 2003, but close to 15 percent (and up to 33 percent in many U.S.
communities) in2006.More precisefigures are unavailable because bankshavenotbeenrequiredtoreporthowmanyoptionARMstheyoriginate(DerHovanesian2006).
Many of these mortgages were created to target less‐creditworthy customers, includingthoseinwhatthebanking industrycalls thesubprimemarket (Baker2009a).Otherswere
marketedto peoplewhowanted tospeculate intheboominghousingmarket,peoplewho
intended to buy and then quickly resell property. However, many unconventional loanswere marketed to ordinary working families who could have handled conventional
mortgages(Marks2008).
Unfortunately,itwasclearfromtheoutsetthatmanyoftheseexoticmortgagescouldneverbe paid back. (For an eye‐opening look at the aggressive marketing of unconventional
mortgages,seeMorgenson,2007).Butwhydidthishappen?Whydidthemortgagemarket
evolveinthisdangerousdirection?
Thisiswheresecuritizationcomesintothepicture.Securitizationissimplythebundlingof
loans—which can include auto loans, student loans, accounts receivable, and, of course,mortgages—and the subsequent selling of bundle shares to investors. In the mid‐1980s,
MinskyreturnedhomefromaconferencesponsoredbytheFederalReserveBankofChicago
andwrotethatsecuritizationwasemergingasakey,newfinancialinnovation. ‘Thatwhichcanbesecuritized,willbesecuritized,’ hewrote(Minsky1990a,64).Hewasright,butway
aheadofhistime.Securitizationofmortgagesexplodedontothesceneinthepastdecade.
Afterthedot‐combubbleburstin2001,housingintheUnitedStateslookedlikeasaferand
moreattractiveinvestment thanevertomanyAmericans,especiallywithlowinterest rates
in placedueto Federal Reserve policy. Still, returns on conventionalmortgageswere toomundane to satisfy the aims of most money managers. As a result, what Minsky and
Schumpeter might have called the ‘financial‐innovationmachine’ turned its attention tohousingandshiftedintohighgear.
Securitizationofmortgagesmeantthathomeloanoriginatorscouldbelessconcernedabout
the creditworthiness ofborrowers than in the past. Thus, theyhad an incentive to steercustomers toward themost profitable types ofmortgages, even if they were the riskiest
(which,ofcourse,theywere)(DerHovanesian2006).TheresultwastheexplosivegrowthinoptionARMs and in ‘nomoneydown’ and ‘no documentation(of income)’ loans.Minsky
warnedofallthisin1992,whenheobservedthatsecuritizationmeansmortgageoriginators
arerewardedaslongastheyavoid‘obviousfraud’(Minsky1992b,22‐23).4
Securitizationworkedlikemagicuponriskymortgages.Insteadof‘garbagein,garbageout,’
risky loanswent into theprocess, butout came bundles that receivedhigh credit ratingsfromagencies likeStandardandPoors.AccordingtoChristopherHuhne,amemberofthe
BritishParliamentandformerrating‐agencyeconomist,part of thechallengeofrating the
bundleswas‘that financialmarketsfall in lovewithnewthings,with innovations,andthe[important] thingaboutnewthingsis that it isverydifficultto assess the realriskinessof
thembecauseyoudon’thaveahistorybydefinition’(Huhne2007).
Another problem is that the rating agencies do not verify the information provided by
mortgage issuers. Instead, they base their decisions on information received from
intermediariesthat, asMinskyput it, ‘do not hazardanyoftheirwealthonthe long termviabilityoftheunderlying[loans]’(Minsky1992b,23).
Moreover, thereare somanymiddlemenin themortgage securitizationgame, includinganumber permitted to operate in a largely unregulated manner, that no one person or
organization canbeeasilyassignedblame in theevent ofdefault.Thechainbetween the
borrowerandtheinvestorincludesrealtors,homeappraisers,mortgagebrokers,mortgageoriginators,investmentbanksthatbundledthemortgages,agenciesthatratedthebundles,
andevencompanies(likeAmericanInternationalGroup) that insuredmanyofthebundles(Whalen2008a,235).5
Trillionsofdollarsworthofmortgage‐backedsecuritieswerebundledandsoldassharesto
investors. Inlate 2008,FannieMaeandFreddieMacaloneheld $4.1 trillion (LanmanandKopecki 2008). Moreover, the private market in credit default swaps—used as a hedge
against(mortgage‐backed)securitieslosses,asawaytospeculatethatothercompanieswillexperiencealoss, orasanarbitrage instrument—reached$45trillionbylate2007(O’Hara
2009,14).
Manyofthemortgagesunderlyingmortgage‐backedsecuritiesarenowinforeclosureorareheadedthere.In2008,2.3millionU.S.homeswentintoforeclosure,up81percentfrom2007
and225percent from 2006(RealtyTrac2009a). Therewereanother803,489filings in thefirst quarterof2009(themostrecentperiodforwhichdataareavailableas thischapteris
beingwritten),up9percentfromthepreviousquarter(RealtyTrac2009b).
Mortgage delinquencies are also up sharply. In February 2009, 7 percent of U.S.homeownerswithmortgageswereat least30dayslateontheirloans,an increaseofmore
than50 percent fromayearearlier.Amongsubprimeborrowers,thatmonth’sdelinquencyratewas39.8percent(Chernikoff2009).6(Again,thesearethelatestavailablefigures.)
Therehasbeenmuchpublicdiscussionoverthepastyearorso intheUnitedStatesabout
recklesshomebuyers,butmortgageseekersalonecouldnotanddidnotbringtheeconomyto itskneeson theirown.Exotichome loans andmortgage securitizationareproductsof
money‐managercapitalism.AsMinskystressedat apairofprofessionalconferences inthelate 1980s and early 1990s, there is a symbiotic relationship ‘between the growth of
securitization and managed money.’ Fund managers, he argued, ‘have outgrown the
orthodoxhighqualitystockandbondportfoliosoffiduciaries’(Minsky1990a,71;1992c,32).
FromaMinskyperspective, theeconomicparticipantsmostresponsibleforbringingdown
the economy are hedge funds and other investment funds, investment banks, andotherfinancial institutions.Lookingathedgefundsoffersaglimpseatwhathappened.Although
thefollowingdiscussionfocusesonhedgefundsbecausetheyarearelativenewcomertothe
scene and have become infamous for operating beyond the reach of much governmentregulation, the investment banks and other institutions played a similar role (and since
1999, U.S. banking has operated without the Glass‐Stegall firewall that separatedcommercialandinvestmentbankingforoverahalfcentury).
Someofthebiggestpurchasersofsecuritizedmortgageshavebeenhedgefunds.Theearliest
ofthesefundswereestablishedinthefirstfewdecadesafterWorldWarIIforthepurposeofseekingabsolutereturns(ratherthanbeatingabenchmarkstock‐market index).Theywere
indeed ‘hedged’ funds, which sought to protect principal from financial loss by hedginginvestments through short selling or othermeans. The numberof hedge funds and the
assets undertheirmanagement expanded in the1990sandgrewevenmorerapidlyin the
2000s.At thesametime, theseassetsbecameincreasingly concentratedat thetop10 firmsand funds becamemore diverse in terms of the strategies their managers employed. In
mid‐2008, theAlternativeInvestmentManagementAssociationestimated that theworld’shedgefunds (basedprimarily intheUnitedStates) weremanaging $2.5 trillion, though it
acknowledged that other estimates were as high as $4 trillion (Ineichen and Silberstein
2008,16).
Thetotalvalueofassetsunderhedge‐fundmanagementisuncertainbecausesuchfundsare
typicallyrestrictedtowealthy individualsandinstitutional investors,whichexempts themfrommostfinancial‐sectorreportingrequirementsandregulation.Takingadvantageoftheir
largelyunregulatedstatus,managersofhedgefundsusedtheirmortgage‐backedsecurities
as collateral to take out highly leveraged loans. They then purchased an assortment offinancial instruments,includingstillmoremortgagebundles.Asaresult,theworld’shedge
funds used securitized mortgages to lay an inherently flimsy foundation for a financial‘houseofcards’(Freeman2009;Holt2009).
Thecurrentcrisisisunmistakablyglobal.It ishavingeconomicandpoliticalramifications
onall continents(‘Timeline’ 2009;Whalen2009).ThetroubleisevenaffectingunexpectedplaceslikeruralChina:factoriesincitiesalongthatnation’scoastarelaying‐offworkersand
sendingthembacktotheirvillages(Lee2009).
Theglobalnatureof thecurrent situationwouldnothavesurprisedMinsky,who stressed
earlyonthatmoney‐managercapitalism‘isinternationalinboththefundsandtheassetsin
funds’ (Minsky1990a,71).Lookingaheadtothecurrent crisis,Minskywrote: ‘Theproblemof finance that will emerge is whether the … institutions of national governments can
contain both the consequences of global financial fragility and an international debtdeflation’ (Minsky1995,93).HeworriedthattheUnitedStateswouldbeunableto serveas
‘the guardian angel for stability in the world economy’ and stressed the need for ‘an
international division of responsibility for maintaining global aggregate grossprofits’(Minsky1986b,15;1990a,71).
Inshort,theglobaleconomyisnowreelingfromtheconsequencesofaclassicMinskycrisis.Its origins are in a housing boom fueled by rising expectations, expanding debt, and
financial innovation.Then thebubble burst, creatingfirsta creditcrunch, then abroader
bankingandstock‐marketcrisis,andnowarecession.
The consequences have been staggering. In thehousing sector, an unprecedented one in
nineU.S.homes (14million) sitsvacant, while another9.4million are forsale (ElNasser2009).TheU.S.stockmarketlostanunprecedented$1.2trillionofvalueinjustasingleday
inlateSeptember2008(measuredbytheWilshire5000),andfor2008overalltheDowJones
industrial averagehad itsworst yearsince 1931 (Twin2008; Blaine2008).Unemploymentmay soon hit doubledigits in theUnited Statesandhas alreadyreacheddouble digits in
somepartsofEurope(Eurostat2009).
Since 2007, the global banking industry has seen an unprecedented shakeout (‘Timeline’
2009),butthereisstilluncertaintyabouthowmuchmoredifficultyliesahead.AstheBank
forInternationalSettlementsindicatedinareportreleasedinJune2007:
Assuming that the big banks have managed to distributemorewidely the risks
inherent in the loans they havemade, who now holds these risks, and can theymanagethemadequately?Thehonestansweristhatwedonotknow.Muchofthe
risk isembodiedinvarious formsofasset‐backedsecuritiesofgrowing complexity
andopacity.Theyhavebeenpurchasedbyawiderangeofsmallerbanks,pensionfunds, insurance companies, hedge funds, other funds and even individuals, who
have been encouraged to invest by the generally high ratings given to theseinstruments(BankforInternationalSettlements2007,145).
WarrenBuffettmadethepointmorevividly:‘Youonlylearnwhohasbeenswimmingnaked
whenthetidegoesout’ (Buffett2008,3).Althoughtherisksarenowbeinglaidbare,itwillstillbesometimebeforetheworldlearnsthefullextentofthefinancialexposure.
4.PublicPolicy
The current global economic situation requires a two‐pronged economic‐policy strategy:
recoveryand reform. Beyond stabilizing the troubledfinancial sector and preventing thecurrent downturnfrombecomingmore severe, theoverarching policyobjectiveshouldbe
greatermacroeconomic stability and broadly shared prosperity in the United States andabroad(Minsky1986c;MinskyandWhalen 1996‐1997).Thissectionhighlightssomeofthe
most important policy issues by comparingMinsky’s recommendations with recent U.S.
governmentaction.7
4.1Recovery
A government strategy for recovery must have at least three components: fiscal policy,
monetarypolicy,andfinancial‐marketpolicy.Eachisconsideredinturn.
ThefoundationofMinsky’sstrategyforavoidinganotherGreatDepressioniswhathecalls‘Big Government’ (Minsky 1986c, 292‐308). At the heart of Big Government is a federal
budget that tendstowardsurplusesin inflationaryperiodsand that producesdeficitslargeenough to stabilize aggregate profits in recessionary periods. Minsky stressed that such
countercyclical spendingshouldbea ‘built‐in’ featureof thebudgetstructure,buthealso
recognizedthatdiscretionaryactionwouldbeneededonoccasion(Minsky1986c,132,292).
Sincethemid‐1970s,however,policymakershaveallowedtheautomaticstabilizingfeatures
oftheU.S.federalbudgettoerode.AsacolleagueandIdemonstratedinlate2002,incometaxes,unemploymentinsurance,welfareexpenditures,andtheminimumwagehavealllost
muchoftheirabilitytoserveascountercyclicalmechanisms.Weconcluded:‘Itmakessense
to shore up the economy’s fiscal stabilizers. Better to fix the roof before the rainbegins’(WhalenandWenger2002,91).Bythetimethestormfinallyhit,however,littlehad
changed.
Theerosionofautomaticstabilizershasforceddiscretionarymeasuresto doall theheavy
lifting. In thecurrent downturn,fiscalpolicy in theUnitedStateshasmovedin theright
direction,buttheinitiativeshavebeentootimid.Thefirststimulusattempt,passedinearly2008, included $100 billion in tax rebates and provided a modest boost to consumer
spending (Broda and Parker 2008), but the bill also included tens of billions in lessstimulative business tax cuts.More recently, President Barack Obama signed into law a
stimuluspackagetotaling$787billionovertwoyears.However,PaulKrugmanwasprobably
correctwhenhesuggestedthepackageshouldhavebeentwiceasbigandevenmoretiltedtowardspending(asopposed to taxcuts),especially since recentdata revisionsshowthat
fourth‐quarterU.S.grossdomesticproductfell by6.3percent,not4.0percent asreportedoriginally(Earnshaw2009;Krugman2009a).8
BeyondgivingamajorroletothefiscalpolicyofBigGovernment,Minskystressedthatthe
central bank must interveneas lender‐of‐last‐resort in response to the threat of a seriouscredit crisis and economiccontraction. ‘Central banksarethe institutions responsible for
containingandoffsettingfinancialinstability,’hewroteinStabilizinganUnstableEconomy,publishedin1986(Minsky1986c,322).Inthatsameyear,Minskyalsocontributedanarticle
emphasizing the globalization of finance and the need for international central‐bank
coordinationtoprepareforthenextbigfinancialcrisis(Minsky1986b).
FromaMinskyperspective,monetary policyhas largely beenon theright track since thecredit crunch hit in mid‐2007. In an effort to stabilize the financial sector and overall
economy, theFederal Reservehasaggressivelycut interest rates,allowedbanksto borrow
from it atnominal rates,andgiven bankscash in exchangefor riskyassets(promising totakeontherisk ifthoseassetsproveworthless).9TheFedhasalsoengineeredbankmergers
andworkedwithothercentralbanksto increasethesupplyofdollarsworldwide.Inaveryshorttime,FedchairmanBenBernankehasmovedalongwayfromthedayswhenhewas
knownasaproponentofinflationtargeting.10
In contrast, financial‐market policy at the U.S. Treasury Department has been woefullyinadequate from a Minsky vantage point. The Troubled Asset Relief Program, more
commonlyknownas the$700 billionWall St. Bailout, seemeddesigned to cleanupbankbalancesheetsbypurchasingtheirbadassets.Instead,theTreasurywassoonwritingbanks
checks andbuying largequantities of bank stocks. The underlying problem of the ‘toxic’
assets remained unresolved, banks remained reluctant to lend, and much of the addedliquiditywastransformedintobankstockdividends.
TheTreasury’s latest plan, a‘public‐privatepartnership’ thatcreatesamarket fortroubledassets with government loans and guarantees, is not much better. The plan offerswhat
JosephE.Stiglitzcallsa‘win‐win‐loseproposal:thebankswin,investorswin—andtaxpayers
lose.’Hearguestheplanencouragesinvestorstobidhighinthatnewlycreatedmarketandsocializes the losses that are likely to follow. In attempting to account for thisproposal,
Stiglitzwrites:‘Perhapsit’sthekindofRubeGoldbergdevicethatWallStreetloves—clever,complex and nontransparent, allowing huge transfers of wealth to the financial
markets’(Stiglitz2009).
A different approach would likelyhavebeenendorsedbyMinsky, who admiredhow theadministration of President Franklin D. Roosevelt closed insolvent banks and assisted
solventonesduringtheGreatDepression.Minskywouldhavealmostcertainlycalledforamorehands‐onsorting‐outofthecurrentfinancialmessbymeansofbankrestructuring.
Today,Krugman(2009b;2009c),DeanBaker(2009b),andJamesK.Galbraith(2009)callfor
similaraction.Forexample,Galbraithwrites:‘Ifthesubprimesecuritiesaretrulytrash,mostof thebigbanksaretroubledandsomeareinsolvent. TheFDICshouldputthemthrough
receivership,get cleanaudits, install newmanagement, andbegin thenecessaryshrinkageofthebankingsystemwiththebigguys,notthesmallones’(Galbraith2009).TheObama
administration recently ordered federal regulators to conduct ‘stress tests’ to gauge the
conditionofthenation’sbanks.Asanextstep,thereceivershipapproachmakesmoresensethancreationofagovernment‐subsidizedmarketfortoxicassets.
Another aspect of financial‐market policy that currently needs attention involves homemortgages.Throughout2008,theUnitedStateslargelyavoidedaddressingtheunaffordable
mortgages that are at the heart of the current problem (Marks 2008). The Obama
administrationhasbeenencouragingthefinancial industrytovoluntarilyrestructurethoseloans, but industrypressurehasmademany inthenation’scapital reluctant to requireit.
Forexample,federal legislatorshavesofarrefusedto letbankruptcyjudgesinsistonhomeloan restructuring, despite the fact that judges can demand a restructuring of all loans
exceptthemortgageonahomeowner’sresidence(legislationisstalledintheU.S.Senateas
ofthiswriting).AlthoughMinskydidnotaddressthisproblemdirectly,hisinterestinsocialjusticeandahumaneeconomysuggesthewouldhaveinsistedthatthisproblemberesolved
by mortgage restructuring and would have been incensed that the problem has beenunresolvedforsolong(Minsky1986c;Minsky1993b).
4.2Reform
Lookingbeyondthecurrentdownturn,areformagendamustincludestricterregulationandsupervision of the financial system, a national commitment to the challenges facing
America’s working families, and U.S. participation in efforts that promote internationaleconomicstabilityandjobcreation.
Minskybelievedthat those responsible forgovernment regulation and supervisionof the
financialsystemwereina‘never‐endingstruggle’withfinancialmarkets(Minsky,quotedinPhillips1997,512).AshewroteinStabilizinganUnstableEconomy,‘Afteraninitialinterval,
thebasicdisequilibratingtendenciesofcapitalistfinancewillonceagainpushthefinancialstructureto thebrinkoffragility.’ Still,hebelieveditwasnecessaryfortheFederalReserve
andregulatorstocontinuethestruggle:‘Theevolutionoffinancialpracticesmustbeguided
to reduce the likelihood that fragile situations conducive to financial instability willdevelop’(Minsky1986c,322,333).
Today, thoseadopting aMinsky perspectivewould hold the sameview. Greaterindustrytransparency,morerigorousbankexaminations,andbroaderregulatoryoversightwouldbe
a good place to start. If policymakers had better information about the extent to which
financial institutions were making use of option ARMs and other exotic instruments,perhaps at least a few would have more aggressively sought to address the mounting
problem. It also seems appropriate to reviveMinsky’snotion of acash‐flow approach tobank examinations,which ‘wouldusetheexaminationprocess togenerate informationon
not onlytheliquidityandsolvencyofparticular institutions,butalso on threats,ifany,to
thestabilityoffinancialmarkets’(Minsky,quotedinPhillips1997,513).Similarly,mortgagebrokers,hedgefunds,andotherinstitutionsthathavegainedincreasingimportanceinthe
past decade deserve greater scrutiny from financial‐system regulators.11 In light of the
current economic crisis, stricter oversight of securitization and other recent financialinnovations are clearly overdue, but the additional need is for regulators to be on the
lookoutforfutureinnovationsinanefforttohead‐offpotentialcrisesbeforetheyoccur.
At the very least, theU.S.government shouldnot block state efforts designed to protecttheir citizens from gaps in federal law. Today, most Americans know about the 2008
Valentine’sDayinWashington that cost formerNewYorkGovernorEliotSpitzerhis job,butofgreaternationalimportancewashisguestcolumnthatappearedinTheWashington
Post thatday.Itdescribedhowthefederalgovernmentstoppedstatesfromcrackingdown
on predatory lending practices. As Spitzer’s essay documents, ‘Not only did the Bushadministration do nothing to protect consumers, it embarked on an aggressive and
unprecedented campaign to prevent states from protecting their residents from the veryproblems to which the federal government was turning a blind eye. …The tale is still
unfolding,butwhen thedust settles,[theBushadministration]willbejudgedasawilling
accomplicetothelenderswhowenttoanylengthsintheirquestforprofits’(Spitzer2008).
Intheageofmanagerialcapitalism(approximately1935‐1982),itmayhavebeensufficientto
focusonfull employment, lowinflationandsteadyeconomicgrowth.Intheageofmoney‐managercapitalism (since 1982), these goals are still important, but thechallengesfacing
America’sworking families requiremoredirect attentionaswell. Americans, like citizens
elsewherearoundtheworld,wanttheopportunitytodevelopandutilizetheirtalentsandtoincrease their standard of living in theprocess. They also want the prospect of an even
betterlifefortheirchildren.
Unfortunately,risingworkerinsecurityistheflipsideofmoney‐managercapitalism.Under
pressurefrommoneymanagers, corporateexecutiveshavelargelyputaside theemployer‐
employee social contract of theNewDeal andthe early decades followingWorldWar II.Employers have moved increasingly toward treating labor as just another ‘spot market’
commodity (Minsky 1996; Minsky and Whalen 1996‐1997; Whalen 1997; Whalen 2008bZalewski2002).
Thus, theeconomic challenges facing theUnitedStatesextendfarbeyondstabilizing the
financial systemandpreventingalonganddeeprecession,asMinskyandIdiscussedinanarticlewrittenshortlybeforehisdeath(MinskyandWhalen1996‐1997).Thenationneedsto
spur the growth of domestic jobs that pay family‐supporting wages and to ensure thatAmericans have access to the education and training such jobs require (Marshall 2010;
GloverandKing2010).Itneedstofindawaytopromotepartnershipsbetweenworkersand
managers, so companies can compete on the basis of innovation, quality, and customerservice,ratherthanbyoutsourcingjobsorslashingwagesandbenefits. Itneedstoprovide
adjustmentassistancetoworkersdisplacedbyinternationaltrade(includingserviceworkers
excluded from some existingbenefits programs) andpublic‐service employment to thoseunable to find private‐sector work. And it needs health‐care reform, retirement‐system
reform,andlabor‐lawreform to addressmedical insecurity, retirement insecurity,andthe
insecurityofworkerswho seek to exercise their legal right to engagein unionorganizingandcollectivebargaining(Whalen2008b;2008c).
ToaddressthechallengesfacingAmerica’sworkingfamilies,theObamaadministrationhascreatedaMiddleClassTaskForce,headedbyVicePresidentJoeBiden.Itsgoalssuggestan
awarenessoftheissuesjustmentioned(‘AbouttheTaskForce’2009).Yetonlytimewilltell
whethertheadministrationdevotesmuchattentionandresourcestotheseissues.
Finally, pursuit ofgreatereconomicstabilityandbroadlysharedprosperitycannot end at
the borders of the United States. Indeed, as suggested above, Minsky recognized thatmoney‐manager capitalism is worldwide in scope andthat stabilization anddevelopment
challengesmustbeaddressedatagloballevel.FromaMinskyperspective,Americansmust
helpfashioninternational institutionsthatnotonlycontainglobalfinancialinstability,butalsoenhancelaborrightsandpromotejobgrowth(Minsky1995;1993a;1990b;1986b;Palley
1999,55).
The world’s key policymakers, however, have been reluctant to move in this direction.12
Indeed,internationaleconomicpolicyhasbeendominatedbyadifferentoutlook,asStiglitz
indicatedafterservingattheWorldBank:
Duringmythree years as chief economist oftheWorldBank, labormarket issues
werelookedatthroughthelensofneoclassicaleconomics. ‘Wagerigidities’—oftenthefruitsofhard‐foughtbargaining—werethoughtpartoftheproblemfacingmany
countries.Astandardmessagewas toincreaselabormarketflexibility.Thenot‐so‐
subtlesubtextwasto lowerwagesandlayoffunneededworkers(Stiglitz,quotedinKomisar2000).
Stiglitz concluded, ‘Theyhad a strategy for jobdestruction. They hadno strategy for jobcreation’ (Stiglitz, quotedinKomisar2000).EconomistswhoseetheworldfromaMinsky
perspectiveneedtocollaboratetodevelopthatmissingstrategy.
5.Conclusion:StandingontheShouldersofMinsky
Minskyusedto say weshould stand on the shouldersofgiants to betterunderstand theeconomy.JustashestoodontheshouldersofKeynesandSchumpeter,wecannowstandon
his shoulders to understand and address the current global recession. From a Minsky
perspective, an explanation of this recession must include cyclical and structuraldimensions,whileapolicystrategyrequiresattentiontobothrecoveryandreform.
The recent attention to Minsky’s ideas, both outside and within the academy, isencouraging.YetwedoourselvesandhismemoryadisservicewhenMinsky’s insights are
reducedtoananalysisofasingleeventorevenoffinancialinstability.Standingsquarelyon
theshouldersofMinskymeansunderstandingthelatestbusinesscyclewithinthecontextofmoney‐managercapitalism,anditmeansseeking toguidethefurtherdevelopmentofthe
systeminamorehumanedirection.
NOTES
1.Homeownerswere alsoable to fuel aconsumptionboomby taking on evenmoredebt.
That is because rising home prices encouraged banks to increase customers’ credit‐cardlimitsandtoheavilypromotehome‐equityloans(ChuandAcohido2008;Story2008).
2.DymskiandPollinadd:‘Whenboomconditionsdoend,aggressivemanagerswillalreadyhavebeen promoted,while cautiousmanagerswill havebeendemoted, if not dismissed.
Moreover, during the slump, all aggressive managers will fail together, so no single
individual will be singled out for blame. This is in contrast to the boom, where themiscalculatingcautiouswillhavebeenisolated’(DymskiandPollin1992,45).
3.Ofcourse,BearStearnsitselfwastobeacasualtyofthecrisisinearly2008.4. Here are some figures that indicate themagnitude of U.S. mortgage securitization: in
early2007,about65percentofmortgageswerebeing turnedintobondsviasecuritization,
up from 40 percent in 1990; and, in the years 2004‐2006, nearly $100 billion per year inoptionARMsweresoldtoinvestors(Pittman2007;DerHovanesian2006).
5.Mortgagebrokers,whooperatewithoutmuchgovernment regulation,accountedfor80percent ofall U.S.mortgageoriginationsin 2006,double theirshareadecadeearlier(Der
Hovanesian2006).
6. According to theFederalHousing FinanceAgency,mortgagedelinquenciesamong themostcreditworthyhomeowners (primeborrowers) holding loansownedorguaranteedby
FannieMaeandFreddieMacrose 50 percent fromDecember2008 to January2009(from497,131to743,686)“asborrowerssaiddropsinincomeortoomuchdebtcausedthemtofall
behind”(Kopecki2009).
7.Theprimaryfocusof thisdiscussion isontheUnitedStates,notmerelybecause this iswheremostoftherecenteconomictroubleoriginated,butalsobecauseitisthemainfocus
ofMinsky’sanalyses.8.Anotherreasonforsuggestingthe2009stimuluswastootimidisthatthefirst‐yeartax‐
cutmultipliersestimatedbyChristineRomerandJaredBernsteinwereconsiderablybelow
1.0(RomerandBernstein2009,12).Thus,modifyingthepackageinthedirectionoftaxcuts(toensurepassage)seemedilladvisedfromamacroeconomicperspective.
9.ItisinterestingtoobservetheFederalReserve’suseofthediscountwindowasameansofinfluencingthebankingsystemduringthecurrentcrisis.MinskyrecommendedthattheFed
increaserelianceonthismechanism throughoutthebusinesscycle,buthethought itwas
especiallyimportant to usethischannel in a fragilefinancial environment (Minsky 1986c,322‐328).
10. Foranunconventional look at Bernanke, including the suggestion ofa surprising linkbetweenMinskyandPrincetonUniversityfinancial‐marketresearchconvenedbyBernanke,
seeLahart(2008).
11.Theuseofleveragebyhedgefundsandthewritingofnodocumentationhomeloansareamongthepracticesingreatestneedofregulatoryattention.
12.Thereluctanceofgloballeaderstocooperateforthepurposeofestablishingafoundationforgreaterstabilityandmorewidespreadglobaleconomicwellbeing canbeseeneven the
currenteconomicclimate;seeZalewskiandWhalen(2009,17‐18).
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