The Olympic Bid Cycle as a form of irrational investing: An application of Minskyian theory

Abstract

Host city bidding for the Olympic Games appears to constitute a form of pro-cyclical irrational investing that leads to multi-billion dollar economic and financial shortfalls and budget over-runs with 100% consistency. The utilisation of Minsky’s Financial Instability Hypothesis (FIH) and Credit Cycle to the Olympic Bid Cycle sheds valuable light on the irrationality of these practices, highlighting a move from stable (hedge) to unstable (speculative) and unsustainable, precarious (ponzi) financing over the life-cycle of an Olympic bid. Application of Minskyian theory to the Olympic Bid Cycle carries important insights for practitioners and policy-makers, extends the analysis of Olympic-Games studies to the post-Classical economics realm, and addresses a wider theoretical call for the utilisation of Minskyian theory outside of a financial markets context. The article concludes with recommendations for further research.

Keywords:

• Minsky
• Olympic Games
• irrational investing
• behavioural finance
• Ponzi financing, hedge financing, speculative financing, Minsky’s Credit Cycle
• Minsky’s financial instability hypothesis
• 2008 financial crisis

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Corrigendum

Public Interest Statement

The Olympic Games could be considered the greatest show on earth, bringing the very best of sport to a global audience, inspiring us to be the best we can be through the communication of Olympic ideals, and engendering national pride as we stand behind our athletes in their journey from event to podium. Yet Olympic Games always overrun (often by $billions), with an amazing 100% consistency. Legacy goals and projected increases in tourism revenue usually fail to materialise, leaving taxpayers responsible for significant financial bailouts, which in turn carry the potential to negatively impact our economies. So why do host cities continue to bid, despite the economic and financial risks that hosting the Olympic Games entails? Minskyian theory sheds valuable light on this compelling and relevant phenomenon, offering fascinating and pragmatic insights into this practice and providing recommendations for future policy and research in this area.

Notes

1. Cycle refers to the lifecycle of the bid, from initial bid announcement stage to post-Games stage.

2. The authors discuss the need for a “generalized Minsky moment” that takes key conceptual components of the theory—such as the notion that “stability is destabilizing” and applies these components in a broad way to other fields, such as international relations. Utilization of Minsky’s theory is thus undertaken using a “generalized” approach of this nature.

3. A term coined by Alan Greenspan in a 1996 speech entitled “The Challenge of Central Banking in a Democratic Society”.

4. A term created by economist John Maynard Keynes in his seminal 1936 work The General Theory of Employment, Interest and Money. Macmillan Cambridge University Press, for Royal Economic Society in 1936.

5. Behavioural finance can be defined as the analysis of what happens when agents fail to act rationally, fail to incorporate new information into their behaviour, or make choices that are not rationally consistent with maximizing expected utility (Barberis & Thaler, 2002, p. 2).

6. Minsky identified a taxonomy of financial structures, or units, explaining that during a period of financial calm, within a robust financial environment, borrowers are, for the most part, able to settle the principal and interest payments on outstanding loans. He referred to this as “hedge” units. As the presence of profit opportunity leads to new activities and innovations, further stimulating growth, agents become less risk averse and likely to take on more debt, increasing speculative positions. At this point, many “hedge” units become “speculative”, where their indebtedness means that their cash flow enables repayment of the interest on loans but not of the principal. Speculative behaviour predisposes an economy to greater investment and growth (and, thus, indebtedness to finance such growth) leading to ultra-speculative behaviour as the economic boom becomes a bubble. This leads many “speculative” financing units to become “Ponzi” financial structures, where interest payments alone exceed the units’ cash flow, leading to refinancing or liquidation. The economy has become inherently fragile and may result in an economic recession, debt deflation, and, possible economic depression in the advent of a shock of some kind (for example unexpected asset price inflation). The excessively leverage of Bear Stearns (40:1), Merrill Lynch (32:1), Morgan Stanley (33:1) and Citi (33:1) in 2008 and the banks inability to meet capital requirements following the subprime bust provide an excellent example of such Ponzi financing and the dangers inherent to it. “… capitalism is inherently flawed, being prone to booms, crises and depressions. This instability, in my view, is due to characteristics the financial system must possess if it is to be consistent with full-blown capitalism” (Minsky, 1982, p. 278).

7. CEOs and Market Woes: Is Poor Corporate Governance to Blame? Wharton University of Pennsylvania, December 10th, 2008: Accessed at: http://knowledge.wharton.upenn.edu/article/ceos-and-market-woes-is-poor-corporate-governance-to-blame/.

8. A concept explored at length by the first author of this article, to which the reader is directed for further elucidation (Zehndorfer, 2015).

9. Warren Buffett, CEO of Berkshire Hathaway and one of the world’s most success investors.

10. NB. Ponzi financing in Minsky’s parlance is not an illegal act, whereas in the case of “Ponzi schemes” the term denotes fraud.

11. Minsky’s (and other behavioural finance and post-Keynesian institutionalist—i.e. post-classical economics).

Additional information

Notes on contributors

Elesa Zehndorfer

Dr Elesa Zehndorfer is author of Charismatic Leadership: The Role of Charisma in the Global Financial Crisis, recently re-released in paperback (Routledge, 2016) and Leadership: A Critical Introduction (Routledge, 2014). Currently Research Officer for British Mensa, and formerly General Secretary of the International Federation of American Football, Dr Zehndorfer was awarded her PhD from the Institute of Sport & Leisure Policy in 2006 and is currently working on a third title for the Routledge Focus series (The Physiology of Irrational Investing: Causes & Solutions: in press).

Chris Mackintosh

Dr Chris Mackintosh is a senior lecturer at Manchester Metropolitan University Business School. Chris has undertaken, managed or commissioned over 100 external research projects in the field of sport policy and has led projects for many major national sports agencies, including Sport England, Sport Wales, Street Games and the Sport and Recreation Alliance. Dr Mackinstosh was awarded a PhD from Liverpool John Moores University in 2016.