Hyman Minsky & The Financial Instability Hypothesis
I first heard of Hyman Minsky and his theory of financial instability via the Pimco website, later I was reminded of Minsky by Grantham’s letters to shareholders. Minsky has a very interesting categorization of financial instability that is likely to help investors understand the crisis. I promise to include more of his in work in the near future.
Article Introduction (Via Goldeagle.com)
Minsky’s research focused on understanding and explanation of financial crisis. 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, like right now, even to companies that can afford loans, and the economy subsequently contracts.
Minsky’s core model is known as “Financial Instability Hypothesis” (FIH), which simply declares stability is inherently destabilizing. “A fundamental characteristic of our economy,” Minsky wrote in 1974, “is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycles.”
Article Excerpts (Via Gold Eagle)
“He opposed the deregulation that characterized the long 18 years of Greenspan era. No wonder we are hearing a lot of talks about regulations recently.”
“Minsky broke down the process from stability to instability into three types of debt phases: hedge, speculative, Ponzi.”
“In these three step process, the tendency of markets becomes more risky as they become seemingly more stable. The longer the markets seem to be stable, or appear more secure, the more risky and unstable they become. The false hope of security leads investors to extrapolate stability into the distant future”