4. The financial instability hypothesis: "endogenous" explanation of the crisis
Hyman Minsky was a post-Keynesian economist whose ideas were rejected in
their time because they were considered “overly radicals” but who currently
(posthumously) has become very famous because his “financial instability
hypothesis” seems to explain quite well the current crisis.
Specifically, Minsky begins considering that economic agents can
basically take three financial positions:
1) Hedge: Investments are
financed in a way that they can fulfill all payment obligations regardless of
the cash flows generated by the investment. Principal and interest payments on
debt are insured for the proper time.
2) Speculative: In this case
the agents bet on the future variations of the price of goods. Revenue flows
generated by investments are adequate to meet the interest payment but the
payment of principal is not guaranteed.
3) Ponzi: In this situation
the payment obligations exceed the revenue stream derived from the investments.
Agents have to borrow more and more to pay debts, so that the final solution is
selling assets to obtain liquidity to afford the payments since the debt
renegotiation is increasingly difficult.
Given this scheme, Minsky’s hypothesis is this: that from a position of
financial stability (hedge) economies will tend, due to its own dynamic, to
positions of financial instability (speculative and ponzi) in which will reach
a point of overall insolvency of the economy with consequent bankruptcies of
companies and banks that this implies (“Minsky’s moment”). In Minsky’s own
words: “The first theorem of the financial
instability hypothesis is that the economy has financing regimes under which it
is stable, and financing regimes in which it is unstable. The second theorem of
the financial instability hypothesis is that over periods of prolonged
prosperity, the economy transits from financial relations that make for a
stable system to financial relations that make for an unstable system”. (17)
To understand why the instability is generalized in the system we must
begin by understanding what happens in the boom phase. Firstly, financial
stability (predominance of the hedge
position) predominates and expectations are optimistic. Because of this
economic agents rely on their ability to meet payments (solvency) and that the future returns on their investments will be
more than sufficient (optimistic estimate
of the marginal efficiency of capital). At the same time, banks,
considering the environment of prosperity and the large amount of funds which
they have available to lend, are more lax at the moment of establishing
restrictions. Although some reluctances may arise on the part of lenders, these
are diluted by the economic strength of the boom phase; system robustness makes
the agents rely on that this one will not fail and therefore begin to take
riskier positions (speculative and ponzi) which contribute, paradoxically,
to making more fragile to the system (paradox
of debt). Thus, the optimistic expectations lead firms to overestimate the performance of their
investments and that banks underestimate
the possibility of default on obligations. In this way it will begin to systematically happen that agents cannot
meet their payment obligations as these exceed the yields obtained. Initially
they will seek to solve this through the debt renegotiation but sooner or later
the agents have to sell their assets to obtain liquidity, a process which leads
to a deflationary episode that finally leads to the crisis with the subsequent
bankruptcy of companies and banks.
Thus, stability creates instability, the robustness the system makes it fragile and optimism leads to pessimism. Here is the great contribution of Minsky facing a discredited Austrian Business Cycle Theory: an “endogenous” explanation of the crisis.
Thus, stability creates instability, the robustness the system makes it fragile and optimism leads to pessimism. Here is the great contribution of Minsky facing a discredited Austrian Business Cycle Theory: an “endogenous” explanation of the crisis.
References:
17) Hyman P.
Minsky, “The financial instability hypothesis”, The Jerome Levy Economics Institute Working,
Paper Nº 74, May 1992.
You can contact the autor of this article in: "Dante Abelardo Urbina Padilla" (Facebook) and dante.urbina1@gmail.com
You can contact the autor of this article in: "Dante Abelardo Urbina Padilla" (Facebook) and dante.urbina1@gmail.com
