Hyman Minsky: Unlocking Financial Wisdom, A Deep Dive into the Legacy of Hyman Minsky

By Fouad Sabry

Who is Hyman Minsky

"Hyman" Philip Minsky was a famous scholar at the Levy Economics Institute of Bard College in addition to being an economist from the United States. He taught economics at Washington University in St. Louis. His research endeavored to provide an understanding and explanation of the characteristics of financial crises, which he linked to oscillations in a potentially fragile financial system. His research attempts to provide this insight and explanation. Minsky is sometimes referred to as a post-Keynesian economist. This is due to the fact that, in the Keynesian tradition, he advocated for some government intervention in financial markets, opposed some of the financial deregulation that occurred in the 1980s, emphasized the significance of the Federal Reserve as a lender of last resort, and argued against the excessive accumulation of private debt in the financial markets.

How you will benefit

(I) Insights about the following:

Chapter 1: Hyman Minsky

Chapter 2: Economic bubble

Chapter 3: Liquidity trap

Chapter 4: Household debt

Chapter 5: Second mortgage

Chapter 6: Real-estate bubble

Chapter 7: Austrian business cycle theory

Chapter 8: Financial crisis

Chapter 9: Real economy

Chapter 10: Modern monetary theory

Chapter 11: Mortgage loan

Chapter 12: Subprime mortgage crisis

Chapter 13: Minsky moment

Chapter 14: Debt deflation

Chapter 15: Causes of the 2000s United States housing bubble

Chapter 16: Credit crunch

Chapter 17: Subprime crisis background information

Chapter 18: Government policies and the subprime mortgage crisis

Chapter 19: Subprime mortgage crisis solutions debate

Chapter 20: Causes of the Great Recession

Chapter 21: 2007-2008 financial crisis

Who this book is for

Professionals, undergraduate and graduate students, enthusiasts, hobbyists, and those who want to go beyond basic knowledge or information about Hyman Minsky.

• Language: English
• Publisher: One Billion Knowledgeable
• Release date: Feb 1, 2024

Book preview

Chapter 1: Hyman Minsky

Hyman Philip Minsky (23 September 1919 – 24 October 1996) was an American economist, economics professor at Washington University in St. Louis, and distinguished scholar at the Levy Economics Institute at Bard College. His study attempted to comprehend and explain the features of financial crises, which he ascribed to fluctuations in a potentially unstable financial system. Minsky is sometimes referred to as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets, opposed some of the 1980s' financial deregulation, emphasized the importance of the Federal Reserve as a lender of last resort, and argued against the overaccumulation of private debt in financial markets.

Minsky was born in Chicago, Illinois, to a Jewish family of Menshevik exiles from Belarus. His mother, Dora Zakon, was involved in the emerging labor movement. Sam Minsky, his father, was involved in the Jewish branch of the Chicago Socialist Party. In 1937, Minsky graduated from New York City's George Washington High School. In 1941, Minsky earned a Bachelor of Science in mathematics from the University of Chicago. He then went on to acquire an M.P.A. and a Ph.D. in economics from Harvard University, where he studied under Joseph Schumpeter and Wassily Leontief.

From 1949 to 1958, Minsky taught at Brown University, and from 1957 to 1965, he served as an assistant professor of economics at the University of California, Berkeley. Professor of Economics at Washington University in St. Louis from 1965 until his retirement in 1990. At the time of his passing, he was a Distinguished Scholar at Bard College's Levy Economics Institute. During his time at Berkeley, he served as a consultant to the Commission on Money and Credit (1957–1961).

Minsky advanced hypotheses tying financial market fragility to speculative investment bubbles endogenous to financial markets within the regular life cycle of an economy. Minsky said that in affluent times, when corporate cash flow exceeds what is required to pay off debt, a speculative frenzy emerges, and shortly after, loans surpass what borrowers can pay off with their incoming earnings, causing a financial catastrophe. As a consequence of such speculative borrowing bubbles, banks and lenders restrict credit availability, even to enterprises that can afford loans, and the economy collapses.

The term Minsky moment refers to this part of Minsky's academic work, which entails the gradual transition of a financial system from stability to fragility, followed by a crisis, for which Minsky is well known.

Contrary to the majority of conventional economists of the time, he maintained that these fluctuations and the accompanying booms and busts are unavoidable in a so-called free market economy – unless the government intervenes to regulate them by legislation, central bank intervention, and other means. In reality, such mechanisms emerged in reaction to crises such as the Panic of 1907 and the Great Depression. Minsky criticized the deregulatory policies of the 1980s.

At the University of California, Berkeley, seminars attended by Bank of America executives helped him develop his theories about lending and economic activity, views he outlined in two books, John Maynard Keynes (1975), a classic study of the economist and his contributions, and Stabilizing an Unstable Economy (1986), as well as more than a hundred professional articles.

Minsky's ideas have garnered significant attention, but they have had little impact on conventional economics or central bank policy.

Minsky expressed his views orally and did not develop mathematical models from them. Minsky preferred to model economies with interlocking balance sheets as opposed to mathematical equations: The alternative to beginning one's theorizing about capitalist economies by positing utility functions over the reals and production functions with something labeled K (called capital) is to begin with the interlocking balance sheets of the economy. Thus, his views have not been included into standard economic models, which do not account for private debt.

The ideas of Minsky, which highlight the macroeconomic hazards of speculative asset price bubbles, have not been integrated into central bank policy. In the aftermath of the 2007–2010 financial crisis, however, there has been a heightened interest in the policy implications of his ideas, with some central bankers asking for a Minsky component to be included into central bank policy.

During the subprime mortgage crisis of the first decade of this century, media attention was refocused on Hyman Minsky's views on debt buildup. The New Yorker refers to this as the Minsky Moment..

The buildup of debt by the non-government sector, according to Minsky, is a crucial factor that drives an economy into a crisis. He classified hedge borrowers, speculative borrowers, and Ponzi borrowers as three categories of debtors that contribute to the buildup of insolvent debt.

The hedge borrower is able to repay debt payments (including principle and interest) using current cash flows from assets. For a speculative borrower, the cash flow from investments may service the loan, i.e. pay the interest due, but the borrower must continually roll over, or re-borrow, the principle. The Ponzi borrower (named after Charles Ponzi; see also Ponzi scheme) borrows based on the belief that the appreciation of the asset's value will be sufficient to refinance the debt, but cannot make sufficient payments on interest or principal with the cash flow from investments; only the appreciation of the asset's value can keep the Ponzi borrower afloat.

These three categories of borrowers materialize as a three-stage structure:

This period happens immediately after a financial crisis and following recovery, when banks and borrowers are excessively cautious. This ensures that the borrower can afford to repay both the principle and the interest by limiting the size of the loan. Consequently, the economy is almost certainly pursuing balance and is nearly self-sufficient. This is the Goldilocks period of debt accumulation: neither too hot nor too cold.

As trust in the financial system is gradually restored, the speculative phase begins to emerge. This assurance induces complacency that favorable market circumstances will persist. Instead of issuing loans to borrowers who can afford to pay both principle and interest, loans are offered to borrowers who can only pay the interest; the principal will be repaid via refinancing. This starts the descent towards insecurity.

Ponzi Phase: As trust in the financial system continues to build and banks remain confident that asset values will continue to rise, the third phase of the cycle, the Ponzi phase, begins. At this point, the borrower cannot afford to pay either the principle or the interest on the loans granted by banks, resulting in foreclosures and massive debt defaults.

If the use of Ponzi finance is widespread enough in the financial system, the inevitable disillusionment of the Ponzi borrower can cause the system to freeze up: when the bubble bursts, i.e. when asset prices stop increasing, the speculative borrower cannot refinance (roll over) the principal, even if able to make interest payments. As with a line of dominoes, the collapse of speculative borrowers might drag down hedge borrowers as well, who are unable to get loans despite the apparent soundness of the underlying assets.

Paul McCulley, an economist, discussed how Minsky's premise applies to the subprime mortgage crisis. McCulley illustrated the three types of borrowing using a mortgage market analogy: a hedge borrower would have a traditional mortgage loan and pay both the principal and interest; a 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 a ponzi borrower would have a negative amortization loan, meaning the payments do not cover the interest. The only reason lenders extended credit to ponzi borrowers was the expectation that home prices would continue to rise.

As of August 2007, McCulley argues that the movement through Minsky's three borrowing phases was clear as the credit and housing bubbles grew. Demand for housing was both a cause and a result of the fast growing shadow banking sector, which helped support the transition to more speculative and Ponzi-style lending by way of ever-riskier mortgage loans with more leverage. This contributed to the development of the housing bubble, since the availability of credit drove up property prices. Since the bubble broke, the process is reversing, as firms de-leverage, lending requirements are tightened, and the proportion of borrowers in the three phases goes back to the hedging borrower.

McCulley also notes that human nature is intrinsically pro-cyclical, which, in Minsky's words, means that Capitalist economies sometimes display inflations and debt deflations that have the potential to spiral out of control. In such instances, the economic system's responses to an economic movement intensify the movement; for example, inflation feeds on inflation and debt-deflation feeds on debt-deflation. In other words, individuals are by nature momentum investors, not value investors. People have a natural tendency to extend the high and low points of cycles. One effect for policymakers and regulators is the introduction of counter-cyclical measures, such as increasing contingent capital requirements for banks during expansions and reducing them during recessions.

Despite the fact that Minsky's research in the 1980s relied on Keynesian analysis, he believed that changes in the structure of the US economy necessitated a new approach, so he turned to Schumpeter. Minsky stated that both Schumpeter and Keynes felt that finance was the motor of investment in capitalist countries, therefore the growth of profit-driven financial institutions could explain the changing character of capitalism through time. Minsky derived from these four phases of capitalism: Commercial, Financial, Managerial, and Money Manager. Each is distinguished by what is being sponsored and who is supporting it.

The initial phase of Minsky was associated with Merchant Capitalism. During this time, banks benefit from their privileged knowledge of faraway banks and local merchants. They issued bills for goods, therefore generating credit for the merchants and a liability for themselves, so guaranteeing payment in the event of unforeseen losses. When a credit agreement was satisfied, the credit was canceled. Banks funded merchants' inventory, but not their capital stock; hence, commerce was the major source of profit, as opposed to industrial expansion as in subsequent centuries. According to Minsky, commercial capitalism may be said to correspond to the structure of finance when production is based on labor and tools rather than labor and equipment.

The industrial revolution prioritized the use of machines in manufacturing and the associated non-labor expenditures. This need for durable assets led to the formation of the corporation as a legal body with limited responsibility for its shareholders. With the expansion of stocks and bonds on the securities markets, investment banks have replaced commercial banks as the primary source of funding. As rivalry between enterprises may result in a reduction in pricing, compromising their capacity to meet current financial obligations, investment banks began encouraging a capital consolidation by enabling trusts, mergers, and acquisitions. The 1929 Stock Market Crash destroyed their economic domination.

Minsky contends, based on Michal Kalecki's profit theory, that the degree of investment drives aggregate demand and consequently the flow of profits (i.e. investment finances itself.) According to Minsky, the Keynesian deficit spending of post-depression economies ensured the flow of profits and permitted the comeback of corporations financing themselves with earnings (something that had not been prevalent since the beginning of capitalism). Minsky argued that the increased independence of management from investment bankers and shareholders led to longer time horizons for company choices, which may be advantageous. However, he counterbalances this by stating that enterprises grew bureaucratized and lacked the dynamic efficiency of early capitalism, becoming prisoners of tradition. Government spending policies that shifted toward supporting consumption rather than the development of capital assets also contributed to stagnation, notwithstanding the lack of depressions and recessions due to steady aggregate demand.

Minsky contends that owing to tax regulations and the manner in which markets capitalized on profits, the value of stock in enterprises with debt was greater than in firms with conservative financing. This resulted in a change, as Minsky described, The fund managers whose income was dependent on the overall returns achieved by the portfolio they managed were eager to accept the higher price for the portfolio assets caused by the refinancing that preceded changes in the ownership of enterprises. In addition to selling the stocks that led to the change in ownership, the money manager purchased the liabilities (bonds) that resulted from the refinancing. Thus, the independence of operational firms from the money and financial markets, which typified managerial capitalism, was a temporary phase. The rise of return- and capital-gains-focused managed money blocks resulted in financial markets once again playing a significant role in determining the economic performance. In contrast to prior periods of finance capitalism, the focus was not on the capital expansion of the economy, but rather on the rapid turn of the speculator, on trading gains.

Minsky observed that the emergence of money management, which included daily trading of multimillion-dollar blocks, led to an increase in securities and individuals adopting financial positions in order to benefit. This placement itself was bank-financed. Minsky observed that, at this stage, financial institutions had gotten so far from the financing of capital expansion that they were devoting huge cash flows to debt validation.

Minsky questioned the neoclassical synthesis' interpretation of The General Theory of Employment, Interest, and Money in his 1975 book John Maynard Keynes. He also presented his own view of the General Theory, one that stressed characteristics that the neoclassical synthesis downplayed or overlooked, such as Knightian uncertainty.

(2013) Ending Poverty Through Employment, Not Welfare. New York: Levy Economic Institute. ISBN: 978-1936192311.

(2008) [First Edition 1975]. McGraw-Hill Professional, New York, John Maynard Keynes, ISBN 978-0-07-159301-4

(2008) [First Edition: 1986]. The Stabilization of an Unstable Economy. New York: McGraw-Hill Professional; ISBN: 978-0-07-159299-4

Can It Happen Again? (1982). ISBN: 978-0-87332-213-3 M.E. Sharpe, Armonk.

Winter of 1981–82 The disintegration of the policy synthesis of the 1960s. New York: Telos Publishing. 166 items archived at the Hyman P. Minsky Archive.

{End Chapter 1}

Chapter 2: Economic bubble

An economic bubble (also known as a speculative bubble or a financial bubble) is a time in which current asset values substantially exceed their intrinsic valuation, which is the valuation that long-term fundamentals support. Bubbles may be produced by excessively optimistic growth expectations (e.g., the dot-com boom) and/or the idea that fundamental value is no longer important when making an investment decision (e.g. Tulip mania). They have occurred in most asset types, including stocks (e.g., the Roaring Twenties), commodities (e.g., the Uranium bubble), real estate (e.g., the US housing bubble of the 2000s), and even obscure assets (e.g. Cryptocurrency bubble). Typically, bubbles emerge from either excessive market liquidity or a shift in investor mentality. Large multi-asset bubbles (such as the Japanese asset bubble of the 1980s and the Everything bubble of 2020–21) are ascribed to central bank liquidity (e.g. overuse of the Fed