Sunday, December 27, 2009

Hyman Minsky

In academic circles Hyman Minsky is now regarded as the great exalted savant of economics, but it wasn't always this way. "Many of Minsky's colleagues regarded his 'financial-instability hypothesis' which he first developed in the nineteen-sixties, as radical, if not crackpot.", writes John Cassidy in a February 4th, 2008 article in The New Yorker entitled 'The Minsky Moment'. You can find a lot of information about Minsky's "financial-instability hypothesis" on the Internet and specifically at Wikipedia, but Robert Barbera sums it up best in his book The Cost of Capitalism: "Minsky's thesis can be explained in two sentences. A long period of healthy growth convinces people to take bigger and bigger risks. When a great many people have made risky bets, small disappointment can have devastating consequences." Barbera also explains the culmination of these consequences: "When you own risky assets that are falling in value you need cash, you have to start selling your good risky assets. If everyone does this at the same time, the price of good risky assets begins to fall, and soon it looks like all risky assets are bad assets. That is the Minsky moment.".

If we delve further into Minsky's 'financial-instability hypothesis' Wikipedia states: "Minsky argued that a key mechanism that pushes an economy towards crisis is the accumulation of debt. He identified 3 types of borrowers that contribute the the accumulation of insolvent debt: Hedge Borrowers; Speculative Borrowers; and Ponzi Borrowers. The 'hedge borrower' can make debt payments from current cash flows from investments. For the 'speculative borrower', the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly rollover or re-borrow the principal. The 'Ponzi borrower' borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with cash flows from investments; only the appreciating value can keep the Ponzi borrower afloat.". We were inundated with Ponzi borrowers at the height of the real estate bubble, both on the individual and institutional level, and this cut the legs out from under the stock market.

There is currently a paradigm shift in academic economic cliques because of the success of the TARP program which not only raises doubts about the conservative free-market economic theories, but also brings back Keynesian postulates. As I wrote in the last posting of this blog, Minsky amalgamates supply-side and demand-side schools of thought and brings economic thinking to a new level. There is a sea change going on and we on Main Street may not be aware of it yet, but those within the inner circles of Wall Street are surely conscious of the influence this has on our portfolios. As is, the smart money piled into the market right at the bottom in March and the little guy, or individual investor, stayed in cash or invested in bonds and in effect, was left holding the bag, although this was a good year for bonds, but nothing like the action in the market. Now that the market has rallied over 60%, individual investors will probably begin buying stocks only to have the market implode again once the government stimulus money runs out. And this is a big part of Minsky's hypothesis, that market collapses are inevitable and part of a healthy economic scenario only to be propped up by a big dose of government intervention.

To gather the material that enabled me to put together this posting I read The Cost of Capitalism by Robert Barbera and thought the book wasn't quite up to snuff. I expected more from Mr. Barbera because he is a good economist and I thought the book took a roundabout way of making his points, plus, some of the interior chapters were laborious when discussing the history of free-market economics since the late 1970's. There is an awful lot about Hyman Minsky in The Cost of Capitalism, but it doesn't warrant the outlay of almost $30 for the price of admission when a simple trip to Wikipedia or a search for Minsky on Google should do the trick. However, it should be noted that although Minsky is not currently part of the mainstream nomenclature or will he ever be, as an investor, you should be aware of his theories because they do effect your profits.