Not since the Great Depression have we felt the full impact of the Minsky Moment. The Great Recession, caused by the subprime mortgage crisis, is a prime example of Hyman Minsky’s economic theory, known in financial circles as The Minsky Moment. Hyman Minsky was an economist and professor of economics who theorized that free market economies, left unregulated by government intervention, would develop boom and bust cycles leading to financial crisis.
Hyman Minsky
Hyman Minsky (September 23, 1919 – October 24, 1996) grew up during the Great Depression, one the nation’s worst financial crisis eras. His parents were actively involved as advocates of both pro-socialist sentiment and labor unions. Minsky began his own career in economics as a student of Mathematics at the University of Chicago. He went on to earn his M.P.A and Ph.D. in Economics from Harvard University. He became an Associate Professor of Economics at the University of California, Berkeley. In 1965 Minsky became Professor of Economics at Washington University in St. Louis.
Financial Crisis
Based on post-Keynesian economic theory, Minsky supported some government intervention in financial markets as a means of maintaining economic stability. He postulated that in a true free market economy, the financial market was fragile leading to potential cycles of economic booms and busts. He believed that during prosperous times debt increases beyond what borrowers are able to pay based on cash flow. As a result, a bubble is formed, where money is borrowed based on asset value and assumed appreciation. When asset value becomes inflated, it forms a bubble. When the bubble bursts the economy gets thrown into a financial crisis.
In response, banks and other financial institutions tighten their lending practices causing the economy to recoil even more, sending the entire economy into a downward spiral. In one sense, this business cycle self-corrects from an over-inflated economic euphoria that led to the unstable economic environment in the first place.
Phases of the Minsky Business Cycle
There are three main phases of Minsky’s business cycle based on borrowing strategies: Hedge borrowing, speculative borrowings and Ponzi borrowing. Each phase of this borrowing strategy is based on an accumulation of debt with increasingly risky loans. The hedge borrower is able to repay interest and principal based on current cash flow. As the cash begins to circulate and credit becomes more available, the economy begins to improve. Borrowers begin to feel comfortable leading to speculative borrowing. Here, the borrower is only able to repay interest, basing the remaining principal on asset value appreciation. At this point, the economy is moving along at a clip and lenders begin offering even riskier loans. Finally, the last and riskiest phase of the business cycle is the Ponzi borrower. At this point, the Ponzi borrower cannot repay the interest or the principal of the loan, and relies on asset appreciation alone. However, when the asset value no longer appreciates and begins to decline the financial crisis begins. Lenders will begin to tighten credit across the board, loans will not be repaid, and a dominoes effect will ripple throughout the financial world – leading to the bust, and subsequently the end of the business cycle.
Hyman Minsky is posthumously receiving his well-deserved recognition and credit in light of the current financial crisis. Hyman Minsky’s financial crisis theory is certainly being played out at in our time. We are definitely living in The Minsky Moment.
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