Comparative Analysis Of H. Minsky Hypotheses To Evaluate The Current Credit Crunch

Introduction:

The proposed research issue is very topical and has a great value in the context of human society. The problem is old as well as very new. The economy is the basic of a nation. So if the civilization exist the issue of the research will remain be the valuable. Though lot of studies and research has been done on this topic, still it is unsolved issue. It is not a new problem but present recession is too deep which could stay long and affect all over the world in a large scale. Some people have the different argument compare to other about causes and remedies. Though there are different argument about the above research problem it is commonly acknowledged that credit crunch bring recession and economical depression. All the problems happened from credit crunch and its causes might view in different perspectives. But the solutions of credit crunch are more complex. The literature review aims to evaluate the current financial crises by revisiting Hyman Minsky's financial instability hypothesis (FIH) (Minsky 1982 and 1986) comparing to other's existing theory. The author of the research has the interest to go in depth of Minsky's advance sensed of shifting of capitalism in a new era of managerial capitalism to money manager capitalism. But it will be discussed in detail to the main report.

Charles J. Whalen (2008) cited that Hyman P Minsky was the foremost U.S expert on credit crunches and financial instability and still now his ideas is very relevant to understand the current economic problem. The most usual word now a day is Minsky Moment coined by McCully in 1998. Minsky moment comes when the lenders are much cautious and restrictive to finance. He is famous for his great idea of ‘stability is unstable'. The current economic crisis is so deep. Economist Langfitt (2007) responded it in a National public radio as, “it's worse than anybody had anticipated, it's pretty disastrous and I'm shocked”.

Demian Perry (2009) said Minsky Moment as a third horseman. According to him the existing economic theory ‘the market efficient' and can predict and model by flip a coin and the market irrational theory is domination last decade became failed to predict and match with the current financial crises. Now the most suitable model is financial instability theory (FIH) and Minsky Moment concerning the housing bubble and financial institutions.

The theory is modelled by three criteria combination of hedge, speculative and ponzi. The Minsky has re-established the cycle of economy in different way. Mainstream economics in general views capitalism as a stable and steady. If any crisis arises, it could arise from preventive policy maker's mistakes or by the external forces. But Minsky contrasting it argued that capitalism is prone to crises from within. There are some criticisms about Minsky hypothesis as well. The critics depicted (FIH) not yet a full-fledged theory. Still now it is lack of some crucial variables and specification. For this reason Tobin (1989) accused his theory as an “implicit theorizing”. But at current situation most of the economist are analysing and discussing the crisis in the perspective of Hyman Minsky model and policy maker's are following the recommendations of Minsky, though Mitchel Y. Abolafia(2009) cited, “Keynes' famous observation that policy makers ‘are often the slaves of some defunct economist.”'

Analysis and discussion:

A credit crunch is known as credit squeeze. When finance crunch or crises in credit reduce the general availability of loans or sudden tightening conditions required to obtain a loan from the banks, then it is accepted as a credit crunch period. The reasons behind credit crunch are numerous but it is obvious that credit crunch bring the recession. Credit crunch changes the relationship between interest rates and credit availability. Basically it is accompanied by a flight to quality by lenders and investors because they seek less risky investments. Charles J. Whalen (2008) described three dimensions liable for present credit crunch. 1) Corporate buyout. 2) Commercial paper. 3) Hedge fund. According to him previously bank was eager to lend for buyout firms. The point was banker had the facility and able to resell the loans to other investors. When portfolios investors see themselves in trouble that they couldn't sell their loans and losing big amount then buyout deals sat idle. Because other investors were not eager to get caught in the same situation. In the second dimension asset-backed commercial paper market which had used to mortgages as collateral was freezing up like buyout loans. The third dimension is hedge fund. It was unconventional; operate in secrecy and for wealthy individuals. Adam smith (1776) had criticized tradesman as they acting together within the guilds and speculate the market. The hedge fund was mostly relied on commercial paper and used for mortgages. When it became clear the borrowers could not fulfil their mortgage obligation then the flow of hedge fund dried up. The entire dimension comes with a result which is called “Minsky moment” by the researcher and economist. The Minsky moment is a situation of economy coined by McCully during the 1998 Russian debt crisis (Lahart 2007). Further George Magnus (2007) explained it more detail. According to the stage is start with a rapid acceleration of debt in which traditional borrowing replaced and new borrowing is for repay the existing loans. After a period of time the moment occurs when lenders become more cautious or restrictive. McCulley, quoted by Lahart (2007) depicted when the Minsky moment keep unchecked it can become “Minsky meltdown” and produce economic recession. Hyman P Minsky used to call himself as a Keynesian. He was the assistant of Alvin Hansen to university of Harvard who was known as a leading Keynes discipline (Whalen, 2008). The two fundamentally distinct views are dominating the market economy. One is smithian view and another is Keynesian views. Ferri and Minsky (1992) explained both of the views. In smithian views they found business cycle is a product of exogenous shocks. Mainly the shocks come from external forces. The most influential force in smithian views is unanticipated public policy. In this view is called as “real business cycle theory” in which believed in full employment during all stages of business cycle. In another view of Keynesian business cycle it is believed that boom and busts, ups and downs is the internal dynamics of market. The Keynesian perspective is, instability is the genuine social problem and it is associated with the increasing of involuntary unemployment. Both of the view previously dominated the market economy proved as inadequate in last few recession periods. Minsky interpret the market economy and business in alternative way and establish a new hypothesis called by financial instability hypothesis (FIH) in his book “john Maynard Keynes” in 1975. This book is new contribution to economy differentiate him from the mainstream economics calling by post-Keynesian economics. According to Demian Perry (2009), the current market hypothesis is “market is efficient” and can be predicted. In this hypothesis it is believed that even individual decision get portfolio value wrong, the market as a whole get them right. It's a smithian view in which financial instruments are driven by an invisible hand. Another one hypothesis is price and value is irrational. The market is driven by mass-psychology, changes in stock price, over react to new information. But Minsky argued the instability is comes from the process of capitalism itself. According to his (FIH) theory, it is obvious to the financial structure of any capitalist economy become more and more fragile in the phases of prosperity. In highly profitable areas, enterprises are taking more amounts debt and their success encourages others to invest in the same sector. Increasing in profit margin fuel the greater indebtedness by easing lenders' worries that new loans might go unpaid (Minsky, 1975). He said it as an evolutionary tendency. Minsky (1989) wrote that the earliest version of financial instability hypothesis emerged in early 1960s. In 1964 he modelled it with three hypotheses. First, the behaviour of real variables depends on the financial structure of the financial system. Second, the likelihood of a financial crisis depends on the financial structure of the economy, which reflects the past history of the economy. Third, the financial structure becomes more and more unstable as the boom proceeds.

The process might convey the mass psychology. The competitiveness and less risky investment also fuel this process. Primarily Minsky explained in his FIH hypothesis that realized profit is determined by investment and expected profit required investment in future. As a result liabilities are upon investment. The financial hypothesis is based on the impact of debt on economic system behaviour. In this theory he takes banking as a profit seeking activity and bankers are like other entrepreneurs in capitalism who innovate new instrument to ensure profit. Minsky (1986) in the expansion of his hypothesis of (FIH) the aspect had described according to the stages of economy in book named “stabilizing an unstable economy”. He showed the financial stages moving from hedge finance to speculative finance and then in the direction of ponzi finance.

He explained hedge financial stage; borrowers got the ability to pay back the outstanding interest and principal according to the loan obligation. In this case, there's nothing to do with hedge fund. In the second situation called by Minsky the speculative case, the borrowers can pay back only the interest but can't repay the principal. As a result they have to have rolling on further financing. In case of the ponzi finance, the borrower's can't pay back the interest or the principal. They have to borrow more and more money only to pay the interest (Minsky, 1982&1986). He described ponzi finances as the critical point where margin of safety become lower and the holders fall in deep debt. He argued bank as hedge economic unit of finance. He further said that if hedge finance dominates the market then it well and we can say it as equilibrium and when speculative and ponzi finance is greater than hedge finance then it is a sign of downturn and the market is disequilibrium.

He also gave much emphasis in his hypothesis on lending as an innovative and profit-driven business. Minsky (1992) depicted that bankers, financial institutions and intermediaries in finance are “merchants of debt, who strive to innovate with regard to both the assets they acquire and the liabilities they market”. Both of his explanation of evolutionary tendency and drive to innovation are most appropriate to the current financial fragility or known as credit crunch. Some example of innovation in lending are CDO, CDS, CDX, special purpose vehicle, equity tranche, super senior tranche, regulatory and ratings arbitrage, teaser rates, no-documentation mortgages, piggyback mortgages and NINJA(quoted by Markus, 2008). All the lending innovation fuel the investment in lending and following the evolutionary tendency comes to the ponzi finance where the borrower can't pay back the interest and principal at all. They are going to be more depended on debt to keep with the loan obligation and scared of bankruptcy. When the lender become sure that the borrower's can't pay back and the investor's are going to lose. The whole scenario changes at a time. The funding becomes shrunk. Loan obligation and requirement become too strict than before. The evolutionary sectors fall, which is termed Minsky moment by Paul McCulley in 1998. The housing boom is appropriate example of this explanation which is liable for the present credit crunch.

Minsky said in 1982 that as acceptable liabilities structure is subjective profiled company has to force for selling its assets when it is shortfall of cash. According to his argument, when anything goes wrong it could be sudden. Christopher Huhne (2007) quoted by Whalen (2008) an MP of the British parliament and economist said, “Financial markets fall in love with new things, with innovations. It is very difficult to assess the real risk of them because you don't have a history by definition”. Minsky explained in 1992 disagreeing the mainstream economic theory that capitalist economy does not rely on exogenous shocks to generate business cycles. It's a kind of impact of debt on system behaviour and it's obvious in a period of time in a specific business. He suggested when the business cycle reach to the so called Minsky moment the collective action is essential. He mostly emphasises on central bank initiatives. In the current scenario, we see the central bank initiative to handle to situation. The bank of England declared the historical lowest rate of interest at .5p (telegraph.co.uk). As a collective action we see the London summit 2009. Most of the prominent country sit together and tried to act collaboratively to cope with the credit crunch. They have declared $1.1 trillion package programme for restoring the growth and job and get back the confidence of financial sector (London summit 2009).

Some of the critics see Minsky's hypothesis is appropriate to a single economic unit (Whalen, 2009). But the view of economic fragility over a period of prosperity was an empirical evident in 1990s of high-tech boom and in housing sector during the early and mid2000s. The insight of Minsky hypothesis though indicated to the financial institution, the prime economic unit influences other like household and other business units in case of availability in finance. Though the (FIH) is experienced before, why it comes again? Dymski and Pollin (1992) depicted that nobody likes to be left behind for underinvestment in a booming sector even though they have full knowledge of the Minsky model and the financial crises will rise at some point. They analysed in the same time aggressive firm and bank loan officers get reward for pursuing profitable opportunities and competitive advantages. Minsky said it is a cyclical path of economy which comes with new financial innovation. In 1990 criticizing the innovation of securitization, he said that “which can be securitized, will be securitized”. Der Hovanesian (2006) criticized that securitization of mortgages steer customers with less concerned about the creditworthiness, toward the most profitable types of mortgages, even they were the riskiest. Minsky (1990) analysed money manager capitalism is international. Further in 1995 he discussed that the problem of finance whether the institutions is national can contain the result of global financial fragility. The present financial crises proved the relevance of Minsky hypothesis which started with housing boom fuelled by rising expectations. The boom sector comes with expanding debt and financial innovations. In the prosperity the bubble burst and credit crunch occurred which turned into banking and stock market crises and finally the recession. Though statistics does not deserve the whole insight but can show the feature. The current recession how deep can be felt little bit by knowing the 12.5 million unemployed only in U.S (discusseconomics.com, June 03 2009), the number of unemployed in UK hits by 2.47(dailyrecord.co.uk, sep 16 2009) and globally only in financial sectors around 350,000 jobs anticipated to go (themoneystop.co.uk, Jan 5, 2009). But how much difficulties lies ahead nobody knows. Buffet (2008) explained as “you only learn who has been swimming naked when the tide goes out”. But how it comes through? Minsky said it cycle of capitalism. Stephen Lendman (8-24-7) described that Minsky developed seven stages to show how the capitalism work. The stages are given below:

Stage-1: displacement

In this stage investor perceptions changed and market disruptions happened due to different types of disturbances. The disturbances may comes from housing bubble, credit squeeze, sub prime mortgages and so on.

Stage-2: price start to rise

From the displacement markets are going to up with price rising due to fundamental improve. Lender and investors begin to notice that it's the time to gain.

Stage-3: easy credit

The fundamental improvement needs help and easy credit. When the conditions improved due to the supportive tools it fuels to speculative finance and more investors jump to borrow to buy new home or other consumer spending. The new finance innovation comes up with a questionable lending. The lender got sloppy and greedy to provide interest only mortgages even though they know its risky and the money could go unpaid.

Stage-4: overtrading

As profit making easier, the investment happened with foolish behaviour. With the trade rise, the shortages in cash flow emerge and output comes with overtrading.

Stage-5: euphoria

It is the most risky stage. The cautious manager and investors become worried about the situation. But the agency and fraudsters still claiming the time got opportunities and market have a long way to go. Stories around to be rich quickly so why should miss it. Even the marginal investors are going to invest in wrong time and get burn.

Stage-6: insider profit taking

The history repeats again. Everybody can feel the things gone too far to control as they previously thought can get out of it. The investors and companies go for force sale due to short flow of cash. According to him it is the beginning of end.

Stage-7: revulsion

The euphoria can turn into revulsion very quick. Because downward momentum is faster than the heading up. In this stage market got panic with unexpected and bad news. Market become infected by mass psychology and humour which makes the investors force sell. The finance becomes dried-up. Cheap credit got ends. The Minsky moment comes up.

Conclusions:

Charles J Whalen, a Minsky analyst and sometimes worked together tried to find for some remedies of Minsky moment. They emphasised on two types of economic policy; recovery and reform. Minsky and Whalen (1996-1997) suggested that to stabilize the financial sector and preventing the downturn and becoming more severe, the policy objectives should be macroeconomic stability and shared prosperity with abroad. For recovery he raise three components must have to consider for the government policies. He argued about fiscal policy, monetary policy and financial market policy to be the most responsible tools for recovery. He termed it as a ‘big government' in 1986 in his article stabilizing an unstable economy. He described it as surpluses in inflationary period to cover in deflationary period. He further argued in 1986 countercyclical spending should be ‘built-in' but he recognised the discretionary action would be needed. Whalen along with Wenger (2002) emphasised on economy's fiscal stabilizer and argued to fix the roof before the rain begins. Abroad in the current scenario, the US and UK the most affected countries are trying to recover by following Minsky suggestions by tax rebates and trying to boost consumer spending. Minsky (1986) emphasised on central bank and recognised as responsible for containing and offsetting financial instability. In the same year he argued about globalization of finance and need for international coordination to prevent the future financial crises. The decisions of cut interest rates and giving banks cash in exchange for risky assets is a perspective of Minsky's monetary policy written in 1986. Mnsky also proposed for financial market policy to get recovery which is followed by bail-out and the troubled asset relief program. But the bail-out and relief program is not working very well as bank and financial institutions reluctant to further lend instead of transforming the liquidity to stock dividends and other issues. The latest plan of ‘public-private partnership' is comes out. Stiglitz (2009) called it ‘win-win-lose' situation in where banks win investors win but taxpayers lose. In this case Minsky preferred president franklin d. Roosevelt strategy of sorting out. He argued for bank restructuring by closed insolvent banks and assisting solvent. But critics said it's a great weakness of Minsky argument as he didn't define the actual situation to consider to take the decision and his three stage of finance (hedge, speculative, ponzi) can't show the actual scenario (Bernanke 1983; Benston and Kaufman 1995)

So it deserves some more specifications. But Krugman, dean baker and k. Galbraith all the authors (2009) call for the similar action proposed by Minsky before. Minsky also suggested for reform. The reforms agenda must required the stricter regulation and supervision with national commitment and promote international economic stability for the financial system. He said it a ‘never-ending struggle' of financial system in financial market. Currently all the financial policy more or less following the Minsky perspective by getting transparency of industry, rigorous bank examinations, use of ARMs as a regulatory instrument. The new innovated finance got lot of scrutiny by financial system regulator. Stuart Calder (2008),The five key strands that He believe will shape the investment landscape of the future are:

  • Massive, accessible computing power, combined with vast arrays of data, such as tick-by-tick price histories.
  • Convergence of liquidity into a handful of global super-exchanges that allow 24 hours investment virtually in any asset.
  • Continuous, mobile access to computing power and data through high-bandwidth connections from super-powerful portable devices.
  • Increased use of artificial intelligence to manage the whole investment process, both for individuals, and collective investments.

Minsky's new perspective of money manager capitalism (since 1982) employers are moving to treat labour as a commodity (Minsky and Whalen, 1996-1997) which is very relevant with the Marxism. Marshall, Glover and king in 2010 argued that nation have to emphasis on growth of domestic jobs with family supporting wages and have the access to the education and training required for the jobs. The also suggested to find out the way of workers-managers partnership. Minsky (1995) had suggested for global coalition to enhance labour rights and promote job growth. But world's key policymakers are tending to be reluctant to follow the direction. The author of the research is interested to discuss it in main report and find out some more of the crises between ‘managerial capitalism' and ‘money manger capitalism'.

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