Arnold Kling  

Carrying Hyman Minsky's Torch

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Robert J. Barbera's new book is called The Cost of Capitalism. On p. 182-183, he writes,

For Minsky, government activism, to thwart the deflationary effects of banking crises, is the cost of capitalism,

In the preface, he writes,

Minsky's thesis can be explained in two sentences:

  • A long period of health growth convinces people to take bigger and bigger risks

  • When a great many people have made risky bets, small disappointments can have devastating consequences.

He keeps referring to the S&L crisis of the 1990's. In my view, the S&L situation was in cleanup mode by then. The crisis was launched when S&L's were caught holding fixed-rate mortgages when inflation took off in the 1970's and especially when interest rates soared in 1980. The crisis entered a second phase after the Garn-St.Germain act of 1982, which freed S&L's to gamble on other investments, without addressing the fact that most of them no longer had capital. But Barbera wants to portray the recession that helped elect Bill Clinton over the first George Bush as caused by the S&L crisis, which strikes me as a stretch.

On p. 39, he writes,

Financiers, we are supposing, recognize that their economy has an unmistakable boom and bust cycle. Armed with this enlightening view, money men and women would try to protect themselves from this boom and bust pattern. How? They would step back from risky lending when an expansion had been going for some years--with the knowledge that recession was sooner or later inevitable. Conversely, early in recoveries the would recommit to risky finance, with the confidence that the next recession was quite a few years down the road.

His point is that we seem to observe the opposite sort of behavior, with financiers destabilizing rather than stabilizing the cycle. As I read this paragraph, I wanted to add "and regulators" when he said "financiers."

Will government do a better job of countercyclical investment than private investors? I guess we are going to find out.

I would describe The Cost of Capitalism as being aimed more at an audience that knows nothing of Hyman Minsky's work. I would hope that readers of this blog would already have acquired some familiarity with Minsky's relevance to the financial crisis.

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COMMENTS (2 to date)
Historical Observer writes:

As a general rule of thumb - when a company or group of companies fail - look to management as the cause. However when an industry fails look to what government either did or did not do.

The S&L crisis had its roots in government interference in the market place. The grand scheme of politicians and regulators went from one bad scenario to another all in the name of garnering political favor both within the industry and ultimately the public that industry served.

The same is true with the mess we have today. Were it not for the combination of the CRA, Fannie and Freddie and the ever meddlesome banking regulators - would a wide number of banks entered into high risk home mortgages that they would have maintained in their portfolios.

While Minsky makes an interesting arguement that sustained growth encourages greater risk taking I think he forgot one key point. The ultimate assumption of risk by the government (with the arguement that they are too big to fail) adds the fire to the gasoline by eliminating moral hazard. When we know from past actions that the government will protect us from our follies than we have no reason to not take foolish risk.

ramsey writes:

The problem with Minsky and all his followers is that they continue to exist in a curious state of denial where they must try to convince themselves that the boom and bust cycles are caused by any assorted combination of vague abstract nouns--but never, ever, by monetary expansion.

This is ridiculous. This is like trying to explain digestion problems without invoking eating as an explanation.

The business cycle is always and forever caused by monetary expansion. Anyone who cannot see that bleedingly obvious fact simply does not understand the business cycle. Of all the non-monetary "explanations" for the business cycle, Minsky's is perhaps the most creative. But it's still utterly wrong without taking into account monetary expansion.

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