The man who saw the meltdown coming had
another troubling insight: it will happen again
Since the global financial system started
unraveling in dramatic fashion two years ago,
distinguished economists have suffered
a crisis of their own.
Ivy League professors who had trumpeted
the dawn of a new era of stability have
scrambled to explain how, exactly, the worst
financial crisis since the Great Depression
had ambushed their entire profession.
"Minsky" was shorthand for Hyman Minsky,
a hitherto obscure macroeconomist who died
over a decade ago.
Many economists had never heard of him
when the crisis struck, and he remains
a shadowy figure in the profession.
But lately he has begun emerging as perhaps
the most prescient big-picture thinker
about what, exactly, we are going through.
A contrarian amid the conformity of
postwar America, an expert in the
then-unfashionable subfields of finance and crisis,
Minsky was one economist who saw
what was coming.
He predicted, decades ago, almost exactly
the kind of meltdown that recently
hammered the global economy.
In recent months Minsky's star has only risen.
Nobel Prize-winning economists talk about
incorporating his insights, and copies of his books
are back in print and selling well.
He's gone from being a nearly forgotten figure
to a key player in the debate over
how to fix the financial system.
But if Minsky was as right as he seems
to have been, the news is not
He believed in capitalism, but also believed
it had almost a genetic weakness.
Modern finance, he argued, was far
from the stabilizing force that mainstream
economics portrayed: rather, it was a system
that created the illusion of stability
while simultaneously creating the conditions
for an inevitable and dramatic collapse.
In other words, the one person who foresaw
the crisis also believed that our whole
financial system contains the seeds of
its own destruction.
"Instability," he wrote, "is an inherent
and inescapable flaw of capitalism."
Minsky's vision might have been dark, but he was
not a fatalist; he believed it was possible
to craft policies that could blunt the collateral
damage caused by financial crises.
But with a growing number of economists eager
to declare the recession over, and the crisis
itself apparently behind us,
these policies may prove as discomforting
as the theories that prompted them
in the first place.
Indeed, as economists re-embrace
Minsky's prophetic insights, it is far from
clear that they're ready to reckon
with the full implications of what he saw.
the study of capitalism would be
as freewheeling and innovative
as its ostensible subject.
But economics has often been subject
to powerful orthodoxies, and never
more so than when Minsky arrived on the scene.
That orthodoxy, born in the years
after World War II, was known as
the neoclassical synthesis.
The older belief in a self-regulating,
self-stabilizing free market had
selectively absorbed a few insights
from John Maynard Keynes,
the great economist of the 1930s
who wrote extensively of the ways
that capitalism might fail
to maintain full employment.
Most economists still believed that
free-market capitalism was a fundamentally
stable basis for an economy,
though thanks to Keynes, some now
acknowledged that government might
under certain circumstances play
a role in keeping the economy - and
employment - on an even keel.
But Minsky was cut from different cloth
than many of the other big names.
The descendent of immigrants from Minsk,
in modern-day Belarus, Minsky was
a red-diaper baby, the son of Menshevik socialists.
While most economists spent the 1950s
and 1960s toiling over mathematical models,
Minsky pursued research on poverty,
hardly the hottest subfield of economics.
With long, wild, white hair, Minsky
was closer to the counterculture
than to mainstream economics.
He was, recalls the economist
L. Randall Wray, a former student, a "character."
So while his colleagues from graduate school
went on to win Nobel prizes and
rise to the top of academia, Minsky languished.
He drifted from Brown to Berkeley and
eventually to Washington University.
Indeed, many economists weren't even
aware of his work.
One assessment of Minsky published in 1997
simply noted that his "work has not
had a major influence in
the macroeconomic discussions
of the last thirty years."
Yet he was busy. In addition to poverty,
Minsky began to delve into the field of finance,
which despite its seeming importance
had no place in the theories formulated
by Samuelson and others.
He also began to ask a simple,
if disturbing question: "Can 'it' happen
again?" - where "it" was, like Harry
Potter's nemesis Voldemort, the thing
that could not
be named: the Great Depression.
to his intellectual hero, Keynes, arguably
the greatest economist of the 20th century.
But where most economists drew a single,
simplistic lesson from Keynes - that government
could step in and micromanage the economy,
smooth out the business cycle,
and keep things on an even keel - Minsky
had no interest in what he and a handful
of other dissident economists
came to call "bastard Keynesianism."
Instead, Minsky drew his own, far darker,
lessons from Keynes's landmark writings,
which dealt not only with the problem
of unemployment, but with money
Although Keynes had never
stated this explicitly, Minsky argued
that Keynes's collective work amounted
to a powerful argument that capitalism
was by its very nature unstable
and prone to collapse.
Far from trending toward some magical
state of equilibrium, capitalism
would inevitably do the opposite.
It would lurch over a cliff.
This insight bore the stamp of his advisor
Joseph Schumpeter, the noted Austrian
economist now famous for documenting
capitalism's ceaseless process
of "creative destruction."
But Minsky spent more time thinking
about destruction than creation.
In doing so, he formulated
an intriguing theory: not only was capitalism
prone to collapse, he argued,
it was precisely its periods of economic
stability that would set
the stage for monumental crises.
Minsky called his idea the "Financial
In the wake of a depression,
he noted, financial institutions
are extraordinarily conservative,
as are businesses.
With the borrowers and the lenders
who fuel the economy all
steering clear of high-risk deals,
things go smoothly: loans are
almost always paid on time,
businesses generally succeed,
and everyone does well.
That success, however, inevitably
encourages borrowers and lenders
to take on more risk
in the reasonable hope
of making more money.
As Minsky observed, "Success breeds
a disregard of the possibility of failure."
As people forget that failure is a possibility,
a "euphoric economy" eventually develops,
fueled by the rise of
far riskier borrowers - what he called
speculative borrowers, those
whose income would cover interest payments
but not the principal; and those
he called "Ponzi borrowers," those
whose income could cover neither,
and could only pay their bills
by borrowing still further.
As these latter categories grew,
the overall economy would shift
from a conservative but profitable environment
to a much more freewheeling system
dominated by players whose survival
depended not on sound business plans,
but on borrowed money
and freely available credit.
any panic could wreck the market.
The failure of a single firm, for example,
or the revelation of a staggering fraud
could trigger fear and a sudden,
economy-wide attempt to shed debt.
This watershed moment - what was later
dubbed the "Minsky moment" - would
create an environment deeply
inhospitable to all borrowers.
The speculators and Ponzi borrowers
would collapse first, as they lost access
to the credit they needed to survive.
Even the more stable players might find
themselves unable to pay their debt
without selling off assets; their forced sales
would send asset prices spiraling downward,
and inevitably, the entire rickety financial edifice
would start to collapse.
Businesses would falter, and the crisis
would spill over to the "real" economy
that depended on the now-collapsing
From the 1960s onward, Minsky elaborated
on this hypothesis.
At the time he believed that this shift
was already underway: postwar stability,
financial innovation, and the receding
memory of the Great Depression
were gradually setting the stage
for a crisis of epic proportions.
Most of what he had to say
fell on deaf ears.
The 1960s were an era of solid growth,
and although the economic stagnation
of the 1970s was a blow to
mainstream neo-Keynesian economics,
it did not send policymakers scurrying
Instead, a new free market fundamentalism
took root: government was the problem,
not the solution.
Yet throughout this period,
the financial system - not the economy,
but finance as an industry - was
growing by leaps and bounds.
Minsky spent the last years of his life,
in the early 1990s, warning of
the dangers of securitization
and other forms of financial innovation,
but few economists listened.
Nor did they pay attention to consumers'
and companies' growing dependence
on debt, and the growing
use of leverage within the financial system.
By the end of the 20th century,
the financial system that Minsky
had warned about had materialized,
complete with speculative borrowers,
Ponzi borrowers, and precious few
of the conservative borrowers
who were the bedrock
of a truly stable economy.
Over decades, we really had forgotten
the meaning of risk.
When storied financial firms started to fall,
sending shockwaves through
the "real" economy, his predictions
started to look a lot like a road map.
"This wasn't a Minsky moment,
" explains Randall Wray.
"It was a Minsky half-century."
Minsky is now all the rage.
A year ago, an influential Financial Times
columnist confided to readers
that rereading Minsky's 1986
"masterpiece" - "Stabilizing an
Unstable Economy" - "helped clear
my mind on this crisis."
Others joined the chorus.
Earlier this year, two economic
heavyweights - Paul Krugman and
Brad DeLong - both tipped their hats
to him in public forums.
Indeed, the Nobel Prize-winning Krugman
titled one of the Robbins lectures
at the London School of Economics
"The Night They Re-read Minsky."
Today most economists, it's safe to say,
are probably reading Minsky for the first time,
trying to fit his unconventional insights
into the theoretical scaffolding
of their profession.
If Minsky were alive today,
he would no doubt applaud
this belated acknowledgment,
even if it has come at a terrible cost.
As he once wryly observed,
"There is nothing wrong
that another depression [won't] cure."
But does Minsky's work offer us
any practical help?
If capitalism is inherently
self-destructive and unstable - never mind
that it produces inequality
as Keynes had observed - now what?
To prevent the Minsky moment
from becoming a national calamity,
part of his solution (which was
shared with other economists)
was to have the Federal Reserve - what
he liked to call the "Big Bank" - step
into the breach and act as a lender
of last resort to firms under siege.
By throwing lines of liquidity
to foundering firms, the Federal Reserve
could break the cycle and
stabilize the financial system.
It failed to do so during the
Great Depression, when it stood by
and let a banking crisis spiral
out of control.
This time, under the leadership
of Ben Bernanke - like Minsky,
a scholar of the Depression - it took
a very different approach,
becoming a lender of last resort
to everything from hedge funds
to investment banks
to money market funds.
Minsky's other solution, however,
was considerably more radical
and less palatable politically.
The preferred mainstream tactic
for pulling the economy out of
a crisis was - and is - based on
the Keynesian notion
of "priming the pump" by sending money
that will employ lots of high-skilled,
unionized labor - by building
a new high-speed train line, for example.
Minsky, however, argued for
a "bubble-up" approach,
sending money to the poor
and unskilled first.
The government - or what he
liked to call "Big Government" - should
become the "employer of last resort,
" he said, offering a job to anyone
who wanted one at
a set minimum wage.
It would be paid to workers who
would supply child care, clean streets,
and provide services
that would give taxpayers
a visible return on their dollars.
In being available to everyone,
it would be even more ambitious
than the New Deal, sharply reducing
the welfare rolls by guaranteeing
a job for anyone who was able to work.
Such a program would not only
help the poor and unskilled,
he believed, but would put
a floor beneath everyone
else's wages too, preventing salaries
of more skilled workers
from falling too precipitously,
and sending benefits up
the socioeconomic ladder.
While economists may be acknowledging
some of Minsky's points on financial instability,
it's safe to say that even liberal policymakers
are still a long way from thinking
about such an expanded role
for the American government.
If nothing else, an expensive
full-employment program would veer far
too close to socialism
for the comfort of politicians.
For his part, Wray thinks that the critics
are apt to misunderstand Minsky.
"He saw these ideas as perfectly
consistent with capitalism," says Wray.
"They would make capitalism better."
But not perfect. Indeed, if there's anything
to be drawn from Minsky's collected work,
it's that perfection, like stability
and equilibrium, are mirages.
Minsky did not share his profession's quaint
belief that everything could be reduced
to a tidy model, or a pat theory.
His was a kind of
existential economics: capitalism,
like life itself, is difficult, even tragic.
"There is no simple answer to
the problems of our capitalism,
" wrote Minsky.
"There is no solution that can be
transformed into a catchy phrase
and carried on banners."
It's a sentiment that may limit
the extent to which Minsky becomes
part of any new orthodoxy.
But that's probably how he would
have preferred it, believes liberal
economist James Galbraith.
"I think he would resist
being domesticated," says Galbraith.
"He spent his career in professional isolation."
the University of Georgia
and author of "A Nation of
Counterfeiters" (Harvard, 2007).
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