You are on page 1of 2

23 March 2014 Last updated at 21:14 ET

Did Hyman Minsky find the secret behind financial crashes?

Ameri can economi st Hyman Minsky, who died in 1996, grew up duri ng the Great Depression, an event whi ch shaped hi s
views and set hi m on a crusade to explai n how it happened and how a repeat coul d be prevented, writes Duncan Wel don.
Minsky spent his life on the margins of economics but his ideas suddenly gained currency with the 2007-08 financial crisis. To many,
it seemed to offer one of the most plausible accounts of why it had happened.
His long out-of-print books were suddenly in high demand with copies changing hands for hundreds of dollars - not bad for densely
written tomes with titles like Stabilizing an Unstable Economy.
Senior central bankers including current US Federal Reserve chair J anet Yellen and the Bank of England's Mervyn King began
quoting his insights. Nobel Prize-winning economist Paul Krugman named a high profile talk about the financial crisis The Night They
Re-read Minsky.
Here are five of his ideas.
Stability is destabilising
Minsky's main idea is so simple that it could fit on a T-shirt, with just three words: "Stability is destabilising."
Most macroeconomists work with what they call "equilibrium models" - the idea is that a modern market economy is fundamentally
stable. That is not to say nothing ever changes but it grows in a steady way.
To generate an economic crisis or a sudden boom some sort of external shock has to occur - whether that be a rise in oil prices, a
war or the invention of the internet.
Minsky disagreed. He thought that the system itself could generate shocks through its own internal dynamics. He believed that
during periods of economic stability, banks, firms and other economic agents become complacent.
They assume that the good times will keep on going and begin to take ever greater risks in pursuit of profit. So the seeds of the next
crisis are sown in the good time.
Three stages of debt
Minsky had a theory, the "financial instability hypothesis", arguing that lending goes through three distinct stages. He dubbed these
the Hedge, the Speculative and the Ponzi stages, after financial fraudster Charles Ponzi.
In the first stage, soon after a crisis, banks and borrowers are cautious. Loans are made in modest amounts and the borrower can
afford to repay both the initial principal and the interest.
As confidence rises banks begin to make loans in which the borrower can only afford to pay the interest. Usually this loan is against
an asset which is rising in value. Finally, when the previous crisis is a distant memory, we reach the final stage - Ponzi finance. At
this point banks make loans to firms and households that can afford to pay neither the interest nor the principal. Again this is
underpinned by a belief that asset prices will rise.
BBC News - Did Hyman Minsky find the secret behind financial crashes?
1 of 2 3/24/2014 6:36 PM
Print to PDF without this message by purchasing novaPDF (
The easiest way to understand is to think of a typical mortgage. Hedge finance means a normal capital repayment loan, speculative
finance is more akin to an interest-only loan and then Ponzi finance is something beyond even this. It is like getting a mortgage,
making no payments at all for a few years and then hoping the value of the house has gone up enough that its sale can cover the
initial loan and all the missed payments. You can see that the model is a pretty good description of the kind of lending that led to the
financial crisis.
Minsky moments
The "Minsky moment", a term coined by later economists, is the moment when the whole house of cards falls down. Ponzi finance is
underpinned by rising asset prices and when asset prices eventually start to fall then borrowers and banks realise there is debt in the
system that can never be paid off. People rush to sell assets causing an even larger fall in prices.
It is like the moment that a cartoon character runs off a cliff. They keep on running for a while, still believing they're on solid ground.
But then there's a moment of sudden realisation - the Minsky moment - when they look down and see nothing but thin air. Then they
plummet to the ground, and that's the crisis and crash of 2008.
Finance matters
Until fairly recently, most macroeconomists were not very interested in the finer details of the banking and financial system. They saw
it as just an intermediary which moved money from savers to borrowers.
This is rather like the way most people are not very interested in the finer details of plumbing when they're having a shower. As long
as the pipes are working and the water is flowing there is no need to understand the detailed workings.
To Minsky, banks were not just pipes but more like a pump - not just simple intermediaries moving money through the system but
profit-making institutions, with an incentive to increase lending. This is part of the mechanism that makes economies unstable.
Preferring words to maths and models
Since World War Two, mainstream economics has become increasingly mathematical, based on formal models of how the economy
To model things you need to make assumptions, and critics of mainstream economics argue that as the models and maths became
more and more complex, the assumptions underpinning them became more and more divorced from reality. The models became an
end in themselves.
Although he trained in mathematics, Minsky preferred what economists call a narrative approach - he was about ideas expressed in
words. Many of the greats from Adam Smith to J ohn Maynard Keynes to Friedrich Hayek worked like this.
While maths is more precise, words might allow you to express and engage with complex ideas that are tricky to model - things like
uncertainty, irrationality, and exuberance. Minsky's fans say this contributed to a view of the economy that was far more "realistic"
than that of mainstream economics.
Anal ysi s: Why Mi nsky Matters is broadcast on BBC Radio 4 at 20:30 GMT, 24 March 2014 or catch up on BBC iPlayer
Follow @BBCNewsMagazi ne on Twitter and on Facebook
BBC News - Did Hyman Minsky find the secret behind financial crashes?
2 of 2 3/24/2014 6:36 PM
Print to PDF without this message by purchasing novaPDF (