Thursday, December 4, 2008

That Minsky Moment

I talked about this before, but it bears repeating: Everybody is wrong about everything, just about all of the time.

The greatest irony is then being completely right about something, capturing and defining an idea or an event so completely that your name will be forever linked to it, and not being around to take credit for it.

For some, I suppose it is a good thing. As is the case of Charles Ponzi.

For the purposes of this post, it is a bad thing.

As is the case of Hymann Minsky, who would later be attributed the phrase "a Minsky moment", the point in time when the willful ignorance of the general public can no longer be maintained, when collapse and the giant flushing sound of the overall economy can be heard by all.

Minsky's insight was on business cycles and their interdependence with financial markets.

Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.

This slow movement of the financial system from stability to crisis is something for which Minsky is best known, and the phrase "Minsky moment" refers to this aspect of Minsky's academic work.

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt (the greatest American export over the past 30 years).

He identified 3 types of borrowers that contribute to the accumulation of insolvent debt: Hedge Borrowers; Speculative Borrowers; and Ponzi Borrowers.

The "hedge borrower" is one who borrows with the intent of making debt payments from cash flows from other investments;

The "speculative borrower" who borrows based on the belief that they can service interest on the loan but who must continually roll over the principal into new investments;


the "Ponzi borrower" who relies on the appreciation of the value of their assets (e.g. real estate) to refinance or pay-off their debt but who does not have sufficient resources to repay the original loan, otherwise.

Minsky, to my knowledge, did not offer any advice on what to do when the terror came.

Panic being essentially a psychological term, not an economic one, is hard for economists to deal with since we more or less assume people are optimizing robots immune to fear.

Being a Keynesian he probably would have advocated some sort of government intervention, although I am not sure if he would support Paulson's current "dump the money in a giant hole" philosophy.

Econolog has some further ruminations on the Ponzi borrowers.

In unrelated (mostly) news, tomorrow (December 5th) is the 75th anniversary of the repeal of prohibition.

Did you know that over 1.4% of the US GDP comes from the beer industry? That Americans drink more beer than wine and spirits combined (do most likely to its lower alcohol content and tastiness)

Help support America and do your part!


Mike S. said...

Thomas Galvin said...

Good stuff:

The one tangible thing that does suffer bubbles is real estate. I suspect this is because real estate is such a long-term investment that it shares many of the traits of representative markets: a wide range of options, opportunities for rapid growth, and frankly numerous possibilities for swindling people.