The Economy, Instability and Hyman Minsky

Commentary By Ron Beasley

In 2004 with the help of the FED and Alan Greenspan the Bush administration was able to create a smoke and mirrors economic recovery that made it possible for George W. Bush to win reelection and the Republicans to hold the House and Senate.  Since the Obama administration has no interest or is opposed to anything that will actually fix the economy it would appear he is going down the same path.  Economic booms and busts have become the rule rather than the exception with each bust more severe than the one before. 

It was with interest that I read this article in the Boston Globe the other day, Why capitalism fails.  It's about an economist who died in 1996 but wouldn't be surprised by out economic plight, Hyman Minsky. 

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.

Minsky was very pro capitalism but recognized it had a genetic weakness  - modern finance.  So is this a Minsky Moment?

There are basically five stages in Minsky�s model of the credit
cycle: displacement, boom, euphoria, profit taking, and panic. A
displacement occurs when investors get excited about something�an
invention, such as the Internet, or a war, or an abrupt change of
economic policy. The current cycle began in 2003, with the Fed chief
Alan Greenspan�s decision to reduce short-term interest rates to one per
cent, and an unexpected influx of foreign money, particularly Chinese
money, into U.S. Treasury bonds. With the cost of borrowing�mortgage
rates, in particular�at historic lows, a speculative real-estate boom
quickly developed that was much bigger, in terms of over-all valuation,
than the previous bubble in technology stocks.

As a boom leads to euphoria, Minsky said, banks and other commercial
lenders extend credit to ever more dubious borrowers, often creating new
financial instruments to do the job. During the nineteen-eighties, junk
bonds played that role. More recently, it was the securitization of
mortgages, which enabled banks to provide home loans without worrying if
they would ever be repaid. (Investors who bought the newfangled
securities would be left to deal with any defaults.) Then, at the top of
the market (in this case, mid-2006), some smart traders start to cash
in their profits. 

While economists may be taking Minsky's advice when it's convenient:

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.

They ignore much of it:

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.�

Minsky's trickle up economics don't fit in a post Reagan trickle down world.  The same appears to apply to regulations on the financial industry that would mitigate the busts because Wall Street owns the House, Senate and White House.