2011 m. liepos 23 d., šeštadienis

Minsky crisis

Minsky crisis

L. Randall Wray
From The New Palgrave Dictionary of Economics, Online Edition, 2011
Edited by Steven N. Durlauf and Lawrence E. Blume

This entry examines the approach of Hyman P. Minsky to financial crisis. Minsky famously developed an ‘investment theory of the cycle and a financial theory of investment’. His thesis was that, over the course of the cycle, behaviour changes in such a way that financial fragility develops. This makes a financial crisis more likely. When the global financial crisis hit in 2008, many commentators returned to the theories of Minsky, calling it a ‘Minsky crisis’ or a ‘Minsky moment’. This entry agrees that Minsky deserves credit for identifying the processes that led up to the crisis. However, it is not sufficient to narrowly constrain the analysis to the transition that occurred over the past decade or so. Beginning in the 1980s and through to his death in 1996, Minsky had been arguing that a new form of capitalism had appeared, which he called ‘money manager capitalism’. In important respects it reproduced the conditions that Hilferding had called ‘finance capitalism’ in the early 20th century – a form of capitalism that collapsed into the Great Depression. What Minsky was arguing was that an extremely unstable form of capitalism had emerged – one based on what is often called financialisation of the economy. He (rightly) feared that it would ultimately lead to a great crash. The rest of the entry looks at Minsky's proposals for reforms that would help to promote stability. Yet, as Minsky always said, stability is destabilising.

financial instability hypothesis; global financial crisis; Hyman Minsky; money manager capitalism; self-regulating markets; stability is destabilizing


Stability is destabilizing. Those three words capture in a concise manner the insight that underlies Minsky’s analysis of the transformation of the economy over the entire post-war period. The basic thesis is that the dynamic forces of the capitalist economy are explosive so that they must be contained by institutional ceilings and floors – part of the ‘safety net’. However, to the extent that the constraints successfully achieve some semblance of stability, that will change behaviour in such a manner that the ceiling will be breached in an unsustainable speculative euphoria. If the inevitable crash is cushioned by the institutional floors, the risky behaviour that caused the boom will be rewarded. Another boom will build, and its crash will again test the safety net. Over time, the crises become increasingly frequent and severe until finally ‘it’ (a great depression with a debt deflation) becomes possible.
While Minsky’s ‘financial instability hypothesis’ is fundamentally pessimistic, it is not meant to be fatalistic (Minsky, 1975, 1982, 1986) According to Minsky, policy must adapt as the economy is transformed. The problem with the stabilizing institutions that had been put in place in the early post-war period is that they no longer served the economy well by the 1980s, as they had not kept up with the evolution of financial institutions and practices. Further, they had been purposely degraded and even in some cases dismantled, often on the erroneous belief that ‘free’ markets are self-regulating. Indeed, that became the clarion call of most of the economics profession after the early 1970s, based on the rise of ‘new’ classical economics with its rational agents and instantaneously clearing markets and the ‘efficient markets hypothesis’ that proclaimed prices fully reflect all information about ‘fundamentals’. Hence, not only had firms learned how to circumvent regulations and other constraints, but policymakers had removed regulations and substituted ‘self-regulation’ in place of government oversight.
From his earliest writings in the late 1950s to his final papers written before his death in 1996, Minsky always analyzed the financial innovations of profit-seeking firms that were designed to subvert New Deal constraints. For example, he was one of the first economists to recognize how the development of the federal funds market had already reduced the Fed’s ability to use reserves to constrain bank lending, while at the same time ‘stretching’ liquidity because banks would have fewer safe and liquid assets should they need to unwind balance sheets (Minsky 1957). And much later, in a remarkably prescient piece in 1987, Minsky had foreseen the development of securitization (to move interest rate risk off bank balance sheets while reducing capital requirements) that would later be behind the global financial crash of 2007 (published as Minsky, 2008) At the same time, Minsky continually formulated and advocated policy to deal with these new developments. Unfortunately, his warnings were largely ignored by the profession and by policymakers – until it was too late.
Minsky’s theory of the business cycle

In the introduction I focused on long-term transformations because too often Minsky’s analysis is interpreted as a theory of the business cycle. There have even been some analyses that attempted to ‘prove’ Minsky wrong by applying his theory to data from one business cycle. Further, the global crisis that began in 2007 has been called the ‘Minsky moment’ or a ‘Minsky crisis’. As I will discuss, I agree that this crisis does fit with Minsky’s theory, but I object to analyses that begin with, say, 2004 – attributing the causes of the crisis to changes that occurred over a handful of years that preceded the collapse. Rather, I argue that we should find the causes of the crisis in the transformation that began in 1951. We will not understand the crisis if we begin with a US real estate boom fueled by lending to subprime borrowers. That will be the topic of the next section.
Now, Minsky did have a theory of the business cycle (see Papadimitriou and Wray (1998) for a summary of Minsky’s approach). He called it ‘an investment theory of the cycle and a financial theory of investment’. He borrowed the first part of that from Keynes: investment is unstable and tends to be the driver of the cycle (through its multiplier impact). Minsky’s contribution was the financial theory of investment, with his book John Maynard Keynes (1975) providing the detailed exposition. In brief, investment is financed with a combination of internal and external (borrowed) funds. Over an expansion, success generates a greater willingness to borrow, which commits a rising portion of expected gross profits (Minsky called it gross capital income) to servicing debt. This exposes the firm to greater risk because if income flows turn out to be less than expected, or if finance costs rise, firms might not be able to meet those debt payment commitments. There is nothing inevitable about that, however, because Minsky incorporated the profits equation of Michal Kalecki in his analysis: at the aggregate level total profits equal investment plus the government’s deficit plus net exports plus consumption out of profits and less saving out of wages (Minsky, 1986). The important point is that all else being equal, higher investment generates higher profits at the aggregate level. This can actually make the system even more unstable, because if profits continually exceed expectations, making it easy to service debt, then firms will borrow even more.
This then leads to Minsky’s famous categorization of financial positions: a hedge unit can meet payment commitments out of income flow; a speculative unit can only pay interest but must roll over principal; and a Ponzi unit cannot even make the interest payments so must ‘capitalize’ them (borrowing to pay interest). (In his classification of ‘Ponzi finance’, Minsky borrowed the name of a famous fraudster, Charles Ponzi, who ran a ‘pyramid’ scheme – in more recent times, Bernie Madoff ran another pyramid that failed spectacularly.) Over a ‘run of good times’, firms (and households) are encouraged to move from hedge to speculative finance, and the economy as a whole transitions from one in which hedge finance dominates to one with a greater weight of speculative finance. Eventually some important units find they cannot pay interest, driving them to Ponzi finance. Honest bankers do not like to lend to Ponzi units because their outstanding debt grows continually unless income flows eventually rise. When the bank stops lending, the Ponzi unit collapses. Following Irving Fisher, Minsky then described a ‘debt deflation’ process: collapse by one borrower can bring down his creditors, who default on their own debts, generating a snowball of defaults. Uncertainty and pessimism rise, investment collapses and through the multiplier income and consumption also fall, and we are on our way to a recession.
But Minsky did not mean to imply that all financial crises lead to recessions, nor that all recessions result from the transition to speculative and Ponzi finance. The Federal government in the post-war period was big – 20–25% of the economy versus only 3% on the verge of the Great Depression. This meant that government itself could be both stabilizing and destabilizing. Countercyclical movement of its budget from surplus in a boom to deficit in a slump would stabilize income and profits (recall from the Kalecki accounting identity above that government deficits add to profits). A rising deficit could potentially offset the effects of falling investment, and, indeed, over the post-war period that helped to cushion every recession. However, it is also possible for the government to cause a downturn by cutting spending – as it did in the demobilization from the Second World War. And if the budget is excessively biased toward surplus when the economy grows, it will generate ‘fiscal drag’ that removes household income and profits of firms – causing a recession. For that reason, a recession could occur well before the private sector is dominated by speculative and Ponzi positions. (Note that an economy that moves toward current account deficits when it grows robustly – such as the USA – will suffer an additional ‘headwind’ that sucks income and profits from domestic households and firms.)
In addition to the ‘big government’, the post-war period also had what Minsky called the ‘big bank’ – the Federal Reserve. The Fed plays a number of roles: it sets interest rates, it regulates and supervises banks, and it acts as lender of last resort. Generally, it moves interest rates in a procyclical manner (raising them in expansion and lowering them in recession), which is believed by many orthodox economists to be stabilizing. Like many heterodox economists, Minsky doubted that spending is very interest-sensitive: in a boom, raising rates by a moderate amount will not curb enthusiasm, and in a bust, even very low interest rates cannot overcome pessimism. In addition, Minsky emphasized the impact of interest rates on financial fragility: raising rates in a boom would increase finance costs and hasten the transition to speculative and Ponzi financial positions, hence, to the extent that tight monetary policy ‘works’, it does so by inducing a financial crisis. Thus, Minsky rejected the notion that the Fed can use interest rates to ‘fine tune’ the economy.
But lender of last resort policy was viewed by Minsky as essential – it would stop a bank run and would help to put a floor to asset prices, attenuating the debt deflation process discussed above. If the Fed lends to a troubled financial institution, it does not have to sell assets to try to cover demands by creditors for redemption. For example, if depositors are demanding cash withdrawal, in the absence of a lender of last resort the bank would have to sell assets to raise the cash required; this is normally difficult for assets such as loans, and nearly impossible to do in a crisis. So the Fed lends the reserves to cover withdrawals.
In sum, the intervention of the big bank and the big government helps to prevent a financial crisis from turning into a deep downturn. The big government’s deficit puts a floor to falling income and profits, and the big bank’s lending relieves pressure in financial markets (Minsky, 1986). A financial crisis can even occur without setting off a recession – a good example was the 1987 stock market crash, in which the Fed quickly intervened with the promise that it would lend reserves to market participants to stop necessitous selling of stocks to cover positions. No recession followed the crash – unlike the October 1929 crash, in which margin calls forced sales of stocks. And the big government deficits kept profits flowing in 1987, again unlike 1929 when the government’s budget was far too small to make up for collapsing investment.
Unfortunately, most Fed policy over the post-war period involved reducing regulation and supervision, promoting the natural transition to financial fragility. From Minsky’s perspective, this was a dangerous combination. While the big bank and the big government reduced the fall-out of crisis, the move to ‘self-regulation’ by financial institutions and markets made riskier behaviour possible. As the fear of failure was attenuated by a government safety net, perceived risk was lowered. Chairman Ben Bernanke (2004) proclaimed the onset of ‘the great moderation’ – a new era of stability. As Minsky argued, though, ‘stability is destabilizing’. In his view, if the government is going to provide a safety net to prop up and ‘validate’ risky behaviour, then the other side of the coin must be greater oversight and regulation, not less. With rapid financial innovation, reduced regulatory oversight, and less fear of a debt deflation process, financial fragility would build until a collapse.
Money manager capitalism and the crisis

Beginning in 2007, the world faced the worst economic crisis since the 1930s. References to Keynesian theory and policy became commonplace, with only truly committed free marketeers arguing against massive government spending to cushion the collapse and re-regulation to prevent future crises. All sorts of explanations were proffered for the causes of the crisis: lax regulation and oversight, rising inequality that encouraged households to borrow to support spending, greed and irrational exuberance, and excessive global liquidity – spurred by easy money policy in the USA and by US current account deficits that flooded the world with too many dollars. While each of these explanations does capture some aspect of the crisis, none of them fully recognizes the systemic nature of the global crisis.
Unfortunately, Minsky died in 1996, but after the crash, his work enjoyed unprecedented interest, with many calling this the ‘Minsky Moment’ or ‘Minsky Crisis’. (Cassidy, 2008; Chancellor, 2007; McCulley, 2007; Whalen 2007) I argued above that we should not view this as a ‘moment’ that can be traced to recent developments. Rather, as Minsky had been arguing for nearly fifty years, what we have seen is a slow transformation of the global financial system toward what Minsky called ‘money manager capitalism’ that finally collapsed in 2007. Hence I call it the ‘Minsky half-century’ (Wray, 2009).
It is essential to recognize that we have had a long series of crises in the USA and abroad, and the trend has been toward more severe and more frequent crises: muni bonds in the mid-1960s; real estate investment trusts in the early 1970s; developing country debt in the early 1980s; commercial real estate, junk bonds and the thrift crisis in the USA (with banking crises in many other nations) in the 1980s; stock market crashes in 1987 and again in 2000 with the dot-com bust; the Japanese meltdown from the early 1980s; Long Term Capital Management, the Russian default and Asian debt crises in the late 1990s; and so on. Until the current crisis, each of these was resolved (some more painfully than others – impacts were particularly severe and long-lasting in the developing world) with some combination of central bank or international institution (IMF, World Bank) intervention plus a fiscal rescue (often taking the form of US Treasury spending of last resort to prop up the US economy to maintain imports that helped to restore rest of world growth).
According to Minsky, the problem is money manager capitalism – the economic system characterized by highly leveraged funds seeking maximum returns in an environment that systematically under-prices risk (Wray, 2009). There are a number of reasons for this. For example, there was the belief in the Greenspan ‘put’ (the Chairman would always intervene to bail out financial markets if problems developed) and the Bernanke ‘great moderation’ – both of which lowered perceived risk. Since the last depression and debt deflation had occurred so long ago, few market participants had any memory of it; indeed, many of those in markets did not even remember the savings and loan crisis of the 1980s! Many of the models that were used to price assets were based on a very short time horizon (five years or less; sometimes this was necessitated by the fact that the financial instruments did not exist previous to that), a period that was unusually quiescent. Further, the rise of ‘shadow banks’ (financial institutions that often had lower costs and less regulation) led to a competitive reduction of risk spreads (pushing interest rates on riskier assets down relative to those on safe assets). Credit ratings agencies played an important role, providing high ratings to assets that proved to be very much riskier than indicated. All of this was made worse by a general ‘euphoric’ belief that prices of assets (such as real estate and commodities) could only go up. Finally, there was an explosion of various types of derivatives that appeared to reduce risk by shifting it to institutions better able to absorb losses. Perhaps the best example was the use of credit default swaps that were used as insurance in case of default; but when the crisis began, it turned out that all the risk came back in the form of counterparty risk (AIG, the seller of the ‘insurance’, could not cover the losses). While we cannot go into all the details here, it was even worse than that because credit default swaps were also used as pure bets on failure (the bettor would win if the assets went bad), and prices of these instruments were used as indicators of the probability of default (rising credit default swap prices could induce credit raters to lower ratings, which then triggered pay-offs on the bets even as they raised borrowing costs for the debtors) (see Wray, 2009).
In sum, contrary to efficient markets theory, markets generate perverse incentives for excess risk, punishing the timid with low returns (Cassidy, 2009). Any money manager who tried to swim against the stream by avoiding excessive leverage and complex and hard-to-value assets found it hard to retain clients. Those playing along were rewarded with high returns because highly leveraged funding drives up prices for the underlying assets – whether they are dot-com stocks, Las Vegas homes, or corn futures. It all works – until it doesn’t. We now know from internal emails that many financial market participants knew that risk was under-priced, but adopted an ‘I’ll be gone, you’ll be gone’ strategy – take the risk, get the millions of dollars in compensation now, and retire when the whole thing collapses.
Many have accurately described the phenomenon as ‘financialization’ – growing debt that leverages income flows and wealth. At the 2007 peak, total debt in the US reached a record 5 times GDP (versus 3 times GDP in 1929), with most of that private debt of households and firms. From 1996 until 2007 the US private sector spent more than its income (running deficits that increased debt) every year except during the recession that followed the dot-com bust in 2000. Financial institution debt also grew spectacularly over the two decades preceding the crisis, totaling more than GDP. Exotic financial instruments exploded – outstanding credit default swaps (bets on default by households, firms, and even countries) reached over $60 trillion, and total financial derivatives (including interest rate swaps, and exchange rate swaps) reached perhaps $600 trillion – many times world GDP.
Some accounts blame subprime mortgages (home loans made to riskier borrowers, typically low income households) for the global financial collapse – but that is too simple. The total value of riskier mortgage loans made in the USA during the real estate boom could not have totalled more than a trillion or two dollars (big numbers but small relative to the total volume of financial instruments). The USA was not the only country that experienced a speculative boom in real estate – Ireland, Spain and some countries in eastern Europe also had them. Then there was also speculation in commodities markets –leading to the biggest boom in history, followed by the inevitable crash – that involved about a half trillion dollars of managed money (mostly US pension funds) placing bets in commodities futures markets (Wray, 2008). Global stock markets also enjoyed a renewed speculative hysteria. Big banks like Goldman Sachs speculated against US state governments, as well as countries like Greece. (For example, Goldman Sachs encouraged clients to bet against the debt issued by at least 11 US states – while collecting fees from those states for helping them to place debt. A common technique was to pool risky debt into securities, sell these to investors, then ‘short’ the securities using credit default swaps to bet on failure. The demand for CDSs for shorting purposes would lead to credit downgrades that raised finance costs and hastened default. The most famous shorter of mortgage debt is John Paulson, whose hedge fund asked Goldman Sachs to create toxic synthetic collateralized debt obligations (CDOs) that it could bet against. According to the US Securities and Exchange Commission, Goldman allowed Paulson’s firm to increase the probability of success by picking particularly risky MBSs to include in the CDOs. Goldman arranged a total of 25 such deals, named Abacus, totaling about $11 billion. Out of 500 CDOs analyzed by UBS, only two did worse than Goldman’s Abacus. Just how toxic were these CDOs? Only five months after creating one of these Abacus CDOs, the ratings of 84% of the underlying mortgages had been downgraded. By betting against them, Goldman and Paulson won – Paulson pocketed $1 billion on the Abacus deals (he made a total of $5.7 billion shorting mortgage-based instruments in a span of two years) and Goldman earned fees for arranging the deals. According to the SEC Goldman’s customers actually met with Paulson as the deals were assembled – but Goldman never informed them that Paulson was the shorter of the CDOs they were buying!)
On top of all this speculative fervor there was also fraud – which appears to have become normal business practice in all of the big financial institutions. It will be years, perhaps decades, before we will unravel all of the contributing factors, including the financial instruments and practices as well as the questionable activities by market players and government officials that led to the collapse. (The Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (commissioned by the US Congress and President Obama) concluded that the crisis was both foreseeable and preventable. It blamed the ‘captains of finance’ (heads of the biggest banks) and the ‘public stewards’ (officials charged with regulating the banks) for the systemic breakdown in accountability and ethics that led to the crisis. Former bank regulator William Black (who blew the whistle on Charles Keating, the convicted felon who ran Lincoln Savings, the biggest thrift to fail as a result of the 1980s crisis, and the patron of five US Senators known as the ‘Keating Five’) is more blunt: the biggest banks in America were run as ‘control frauds’ designed to enrich top management while defrauding customers and shareholders. By his reckoning, thousands of individuals committed go-to-jail fraud. Only time will tell whether they will be brought to justice.)
This much we do know: the entire financial system had evolved in a manner that made ‘it’ – an economic collapse and debt deflation – possible. Riskier practices had been permitted by regulators, and encouraged by rewards and incentives. Lack of oversight and prosecution led to a dramatic failure of corporate governance and risk management at most big institutions (see the Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States). The combination of big government and big bank interventions plus bail-outs of ‘too big to fail’ institutions in crisis after crisis since the 1960s let risk grow on trend. The absence of depressions allowed financial wealth to grow over the entire post-war period – including personal savings and pension funds. All of these funds needed to earn returns. As a result, the financial sector grew relative to GDP – as a percentage of value added, it grew from 10% to 20%, and its share of corporate profits quadrupled from about 10% to 40% from 1960 to 2007 (Nersisyan and Wray, 2010). It simply became too large relative to the size of the economy’s production and income. The crash was the market’s attempt to downsize finance – just as the crash in 1929 permanently reduced the role played by finance, and allowed for the robust growth of the post-war period. Beginning in summer 2007, a series of runs on financial institutions began that would have snowballed without unprecedented intervention by governments around the world. Typically these took the form of a refusal by markets to ‘refinance’ banks. Recall from above that debt of financial institutions had grown tremendously, as they borrowed mostly short-term to finance positions in financial assets. Often this took the form of overnight borrowing plus very short-term commercial paper on the basis of high-quality collateral. As the crisis unfolded, borrowers had to pledge more and more collateral, and pay higher and higher interest rates to borrow. By fall of 2007, the ‘haircut’ (a 10% haircut means the bank can borrow 90 cents against each dollar of good collateral) was so large that many financial institutions could no longer borrow enough to finance their positions in assets – meaning they had to sell assets into a market that now feared risk. Such ‘fire sales’ would lead to what Irving Fisher and Minsky called a ‘debt deflation’. At the same time, worried shareholders began to dump bank stocks. Without prompt rescue by governments, the ‘market’ would have operated in a manner that would have led to failure of most institutions. US Treasury Secretary Timothy Geithner later said that ‘none of [the biggest banks] would have survived a situation in which we had let that fire try to burn itself out’ and Fed Chairman Ben Bernanke said ‘As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history… out of maybe the 13, 13 of the most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two’ (Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, p. 354).
It is important to include as contributing factors the erosion of New Deal institutions that had enhanced economic stability, including most importantly the creation of a high-consumption, high-employment and high-wage society. As Minsky (1986, 1996) argued, the USA emerged from the Second World War with powerful labour unions that were able to obtain good and growing wages, which fueled growth of domestic consumption out of income. According to Minsky, debt loads were extremely low in the private sector – with debts having been paid down or wiped out by bankruptcy in the Great Depression – and with lots of safe government bonds held as assets. In combination with a strengthened government safety net (Social Security for the aged, welfare and unemployment compensation for those without jobs, the GI bill for soldiers returning home, low interest rate loans for students) this meant that consumption comprised a relatively larger part of GDP. For Minsky, consumption out of income is a very stable component – unlike investment, which is unstable. Minsky argued that investment-led growth is more unstable than growth led by a combination of consumption out of income plus government spending because the second model does not lead to worsening private sector balance sheets.
However, over the course of the past four decades, union power declined. Minsky frequently claimed that the most significant action taken during the Reagan administration was the busting of the air traffic controllers’ union (which, he claimed, sent a message to all of labour). Median real wages stopped growing, consumer debt grew on trend (and then exploded after 1995), and the generosity of the safety net was reduced. Further, over the whole period, policy increasingly favoured investment and saving over consumption – with favourable tax treatment of savings and investment, and with public subsidies of business investment. Federal government also stopped growing (relative to the size of the economy) and its spending shifted away from public infrastructure investment. Inequality grew on trend, so that it actually surpassed the 1929 record inequality. President Bush even celebrated the creation of the ‘ownership society’ – ironically, with concentration of ownership of financial assets at the very top (Wray, 2005). The only asset that was widely owned was the home, which then became the basis for a speculative real estate bubble that produced financial assets traded around the world. The global financial collapse and deep recession in the USA after 2007 then generated widespread foreclosures (13 million by 2012) – with families kicked out of their homes, owing lots of debt, and with real estate prices collapsing so that vulture hedge funds could buy up blocks of houses at pennies on the dollar. By 2010 the home ownership rate in the USA had returned to the pre-boom level.
The 1929 crash ended what Minsky and Rudolf Hilferding designated the finance capitalism stage (Wray, 2009) Perhaps the global financial crisis of 2007 will prove to be the end of this stage of capitalism – the money manager phase. Of course, it is too early to even speculate on the form capitalism will take in the future. In the final section I will look at the policy response that could help to reformulate global capitalism along Minskian lines.
Minskian policy in the aftermath of the collapse of money manager capitalism

Minsky (1986) argued that the Great Depression represented a failure of the small-government, laissez faire economic model, while the New Deal promoted a Big Government/Big Bank highly successful model for financial capitalism. Following Minsky, we might say that the current crisis represents a failure of the Big Government/Neoconservative (or, outside the USA, what is called neo-liberal) model that promotes deregulation, reduced supervision and oversight, privatization, and consolidation of market power. It replaced the New Deal reforms with self-supervision of markets, with greater reliance on ‘personal responsibility’ as safety nets were reduced, and with monetary and fiscal policy that is biased against maintenance of full employment and adequate growth to generate rising living standards for most Americans. Even before the crisis, the USA faced record inequality, a healthcare crisis, and high rates of incarceration, among other problems facing the lower and middle classes (Wray 2000, 2005). All of these trends are important as they increase insecurity and the potential for instability, as Minsky described in one of his last published pieces (Minsky 1996).
We must return to a more sensible model, with enhanced oversight of financial institutions and with a financial structure that promotes stability rather than speculation. We need policy that promotes rising wages for the bottom half so that borrowing is less necessary to achieve middle class living standards. We need policy that promotes employment, rather than transfer payments – or worse, incarceration – for those left behind. Monetary policy must be turned away from using rate hikes to pre-empt inflation and toward a proper role: stabilizing interest rates, direct credit controls on bank lending to prevent runaway speculation, and stronger bank supervision. (A central bank could, for example, increase margin requirements on lending to speculators, raise required down payments for bank real estate lending, and set limits on bank lending for specified purposes in a euphoric boom.)
Minsky insisted that ‘the creation of new economic institutions which constrain the impact of uncertainty is necessary’, arguing that the ‘aim of policy is to assure that the economic prerequisites for sustaining the civil and civilized standards of an open liberal society exist. If amplified uncertainty and extremes in income maldistribution and social inequalities attenuate the economic underpinnings of democracy, then the market behavior that creates these conditions has to be constrained’ (Minsky, 1996, pp. 14, 15). It is time to take finance back from the clutches of Wall Street’s casino.
Minsky had long called for an ‘employer of last resort’ program to provide jobs to those unable to find them in the private sector. In a sense this would be a counterpart to the central bank’s ‘lender of last resort’ program. In the jobs program, government would offer a perfectly elastic supply of jobs at a basic program wage. Anyone willing to work at that wage would be guaranteed a job. Workers would be ‘taken as they are’ – whatever their level of education or training – and jobs would be designed for their skill level. Training would be a part of every job – to improve skills and to make workers more employable outside the program. The work would provide useful services and public infrastructure, improving living standards. While Minsky is best known for his work on financial instability, his proposal for the employer of last resort program received almost as much of his attention, especially in the 1960s and 1970s. Interested readers are referred to the growing body of work on use of job guarantee programs as part of long-term development strategy (Bhaduri, 2005; Felipe et al., 2009; Hirway, 2006; Minsky, 1965; Mitchell and Wray, 2005; Tcherneva and Wray, 2007; Wray, 2007). Note that this would help to achieve Minsky’s goal of a high-employment economy with decent wages to finance consumption. Minsky always saw the job guarantee as a stabilizing force – and not something that is desirable only for humanitarian reasons.
The global crisis offers both grave risks as well as opportunities. Global employment and output collapsed faster than at any time since the Great Depression. Hunger and violence grew after the financial crisis – even in developed nations. The 1930s offer examples of possible responses – on the one hand, nationalism and repression (Nazi Germany), on the other a New Deal and progressive policy. From a Minskian perspective, finance played an outsized role in the run-up to the crisis, both in the developed nations, where policy promoted managed money, and in the developing nations, which were encouraged to open to international capital. Households and firms in developed nations were buried under mountains of debt even as incomes for wage earners stagnated. Developing nations were similarly swamped with external debt service commitments, while the promised benefits of Neoliberal policies often never arrived.
Minsky would probably argue that it is time to put global finance back in its proper place as a tool to achieving sustainable development, much as the USA did in the aftermath of the Great Depression. This means substantial downsizing and careful re-regulation. Government must play a bigger role, which in turn requires a new economic paradigm that recognizes the possibility of simultaneously achieving social justice, full employment, and price and currency stability through appropriate policy.
See Also

banking crisis;
credit crunch chronology;
European Central Bank and monetary policy in the Euro area;
euro zone crisis 2010

Bernanke, B. S. 2004. The Great Moderation . Speech given at the meetings of the Eastern Economics Association, Washington DC, 20 February. Available at http://www.federalreserve.gov/Boarddocs/Speeches/2004/20040220/default/htm. Accessed 12 May 2009.

Bhaduri, A. 2005. Development With Dignity: a Case for Full Employment . National Book Trust, India.

Cassidy, J. 2008. The Minsky moment. The New Yorker , 4 February. http://www.newyorker.com/. Accessed 29 January 2008.

Cassidy, J. 2009. How Markets Fail: the Logic of Economic Calamities . Picador, New York.

Chancellor, E. 2007. Ponzi Nation. Institutional Investor , 7 February.

Felipe, J., Mitchell, W. and Wray, L. R. 2009. A reinterpretation of Pakistan’s ‘economic crisis’ and options for policymakers. Manuscript, Asian Development Bank.

Hirway, I. 2006. Enhancing livelihood security through the National Employment Guarantee Act: toward effective implementation of the Act. The Levy Economics Institute Working Paper No. 437 . http://www.levy.org/.

McCulley, P. 2007. The plankton theory meets Minsky. Global Central Bank Focus , March. PIMCO Bonds: http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/1999-2001/FF_01_2001.htm. Accessed 8 March 2007.

Minsky, H. P. 1957. Central banking and money market changes. Quarterly Journal of Economics , 71 (2), 171.

Minsky, H. P. 1965. The role of employment policy. In: Poverty in America (ed. M. S. Gordon ). Chandler Publishing Company, San Francisco, CA.

Minsky, H. P. 1975. John Maynard Keynes . Columbia University Press, New York.

Minsky, H. P. 1982. Can it Happen Again? M. E. Sharpe , Armonk, NY.

Minsky, H. P. 1986. Stabilizing an Unstable Economy . Yale University Press, New Haven and London.

Minsky, H. P. 1996. Uncertainty and the Institutional Structure of Capitalist Economies . The Levy Economics Institute of Bard College, Working Paper No. 155.

Minsky, H. P. 2008 (1987). Securitization . Levy Economics Institute of Bard College, Policy Note No. 2, 12 May.

Mitchell, W. F. and Wray, L. R. 2005. In defense of employer of last resort: a response to Malcolm Sawyer. Journal of Economic Issues , 39 (1), 235–245.

Nersisyan, Y. and Wray, L. R. 2010. Transformation of the financial system: financialization, concentration, and the shift to shadow banking. In Minsky, Crisis and Development (eds. D. Tavasci and J. Toporowski ), pp. 32–49. Palgrave Macmillan, Basingstoke.

Papadimitriou, D. B. and Wray, L. R. 1998. The economic contributions of Hyman Minsky: varieties of capitalism and institutional reform. Review of Political Economy , 10 (2), 199–225.

Tcherneva, P. R. and Wray, L. R. 2007. Public employment and women: the impact of Argentina’s Jefes Program on female heads of poor households. Levy Economics Institute Working Paper No. 519. http://www.levyinstitute.org/publications/?docid=965.

Whalen, C. 2007. The U.S. credit crunch of 2007: a Minsky moment. Levy Economics Institute Public Policy Brief , No. 92. http://www.levy.org/.

Wray, L. R. 2000. A new economic reality: penal Keynesianism. Challenge , September–October, 31–59.

Wray, L. R. 2005. The ownership society: social security is only the beginning. Levy Economics Institute Public Policy Brief , No. 82. http://www.levy.org/.

Wray, L. R. 2007. The employer of last resort programme: could it work for developing countries? Economic and Labour Market Papers , 2007/5, International Labour Office, Geneva.

Wray, L. R. 2008. The commodities market bubble: money manager capitalism and the financialization of commodities. Levy Economics Institute Public Policy Brief , No. 96. http://www.levy.org/.

Wray, L. R. 2009. The rise and fall of money manager capitalism: a Minskian approach. Cambridge Journal of Economics , 33 (4), 807–828.

How to cite this article

Randall Wray, L. "Minsky crisis." The New Palgrave Dictionary of Economics. Online Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2011. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 23 July 2011 doi:10.1057/9780230226203.3852