Are Financial Collapses Unavoidable?

Posted: September 22nd, 2009 | Author: Steve | Filed under: Business, Capitalism | Comments

I recently read the article Why Capitalism Fails by Stephen Mihm and was interested to learn about Hyman Minski, who, according to the article, was

…a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck… But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through…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.

Minsky basically believed that the conservative fiscal stance which comes in the wake of a financial collapse, such as the Great Depression, would inevitably sow the seeds for the next crisis decades down the road. The main ingredients are time and short human memories, “Instability,” he wrote, “is an inherent and inescapable flaw of capitalism.” The article compares Minsky’s view to the one held by mainstream economics, that capitalism is self-regulating and self-stabilizing, known as the Neoclassical Synthesis.

Having a Minsky Moment

Minsky’s theory, known as the “Financial Instability Hypothesis,” works like this: in the wake of a financial collapse, the remaining lending institutions will see to take on less risk and revert to extremely conservative practices, which results in everything running smoothly for a while. As time goes by, and people are farther and farther removed from the source event, they are more and more willing to take on risk. Ultimately, this leads to greater and greater speculation, as more and more risky borrowers enter the market, what Minsky called a “euphoric economy”.

The end comes when the riskiest of borrowers enter the market, those whose borrowing can only be paid for with more borrowing, essentially a Ponzi scheme. Once the economy enters this fragile state, it only takes one small incident to topple the whole house of cards (This moment is referred to as the “Minsky Moment”), as everyone tries to shed risk and the cycle basically starts again.

If any of this sounds eerily familiar, that’s because it is exactly what happened this time.

Damage Control

Minsky suggested that it may be possible to mitigate some of the damage by implementing some policies that you also may be familiar with. The first would be a monetary policy in which the Fed would serve as the lender of last resort, in order to stop the bleeding and keep credit flowing. This policy was not implemented in time during the Great Depression and may be what led to it being so long and so deep. It has been implemented widely during the current fiscal crisis, although it is too soon to tell if has worked, although the signs are promising.

The second of Minsky’s policies was that the government should also act as the “employer of last resort”, employing everyone in need of a job at some minimum wage, and putting them to work on socially beneficial task. A form of this policy was used by Teddy Roosevelt and others during the Great Depression, and resulted in much of the infrastructure we currently use, such as bridges, highways and national parks. However, this policy has not been implemented by our current and recent leaders, which brings me to the real point of this article.

I find it interesting how easily the our current government, whether Democrat or Republican, found it to implement one part of Minsky’s plan, being the lender of last resort for financial institutions, yet finds it unpalatable to implement the other half, i.e. putting people to work. It is odd how people like Fed Chairman Ben “Helicopter” Bernake and President Obama have so eagerly adopted only the part of the plan which benefits business and financial institutions.

Odd how one is called “socialism” while the other is called “good business”. I believe that we may be leaning towards the form of government known as corporatism. (Some would call this a form of fascism, although not in the nationalistic sense.)

Too Many Clunkers

Our government seems to be much more willing to put corporations first, by funelling money to one pork project or another. Cash for Clunkers is a perfect example. While it did provide a short-term boost to auto dealers and auto manufacturers, it neglected the fact that people without jobs can’t afford to buy a car at any price, and the program ended up selling a lot of second and third cars. The people at the bottom were left out again. Perhaps the focus should be on putting people to work first, and if it is useful work, so much the better. I can’t even begin to imagine how many people we could put to work at a minimum wage for the amount of money that has been spent on bailing out large corporations.

The thing is, we need both. Corporations need credit to make things, and individuals need jobs so that they can buy what the companies make. As Henry Ford figured out, you can’t have one without the other. Perhaps a system that is skewed solely towards those with money and power, and ignores those without, is more aristocracy than meritocracy, and something that should be avoided.

Your Opinion

What do you think? Was Minsky right? Are we focusing too much on bailing out companies and ignoring the little guy? Please post your opinion in the comments.

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This article originally appeared on TriplePundit and is reprinted here thanks to 3P’s Creative Commons Attribution 3.0 license. You can find out more about Creative Commons licensing here.