Preventing Financial Crises: A Vital Yet Frequently Overlooked Aspect of Minsky's Economics

Abstract:

Periods of financial instability are always an opportunity for Hyman P. Minsky to return to the spotlight. Often, they result in an increase in the number of references made to Minsky's work, otherwise relegated to the margins of academic debate. For the most part, this work involving Minsky is limited to demonstrating the relevance of the Financial Instability Hypothesis in explaining the mechanisms of financial fragility or the need to implement countercyclical measures during the acute phase of the crisis. In my view, such a use of Minsky's work is incomplete because it fails to take into account an equally important aspect of it: that which relates to the prevention of financial crises.

Keywords::

• Minsky
• financial regulation
• instability

JEL Classification Codes::

• E12
• B52
• G01

Notes

¹ Bronfenbrenner's publication of Is the Business Cycle Obsolete? in 1969 shows how, during this period, the question of financial crisis analysis seemed to have become outdated.

² On this question of equilibrium, it is important to note that Minsky has repeatedly rejected approaches associated with general equilibrium by pointing out that neither the unity of equilibrium nor its stability has been demonstrated (Minsky 1986b; Minsky and Campbell 1988, 4; Minsky [1986] 2008)

³ Minsky distinguishes three types of financing: Hedge when expected cash flows make it possible to repay principal and interest; Speculative when they are just sufficient to cover interest; and Ponzi when they do not even cover interest charges.

⁴ In this way, economic difficulties spread to other economic units due to “the principle of double-entry accounting, whereby credits [of certain economic units] are debits [of other units… inasmuch as] each balance sheet entry has a counterparty.” (Minsky 1996b, 4)

⁵ It should be noted that in Chapter 13 of SUE (Minsky [1986] 2008) and in the Challenge article “Money and the Lender of Last Resort” (Minsky 1985), there is an effort to summarize the main measures to be implemented.

⁶ This LOLR function reflects the idea of a perfectly accommodating central bank that is able to provide the economy with the liquidity it needs to function properly.

⁷ To illustrate the low amounts allocated by the discount window, we can specify that between January 1990 and July 2007, the average amount of funds borrowed each week via the discount window was $234 million (i.e., on average 100 times less than via the Open Market) (Bentoglio and Guidoni 2009).

⁸ Real Estate and Investment Trusts

⁹ These innovations included the introduction of anonymous auctions, access to larger amounts of liquidity, and successive reductions in the penalty for accessing the discount window.

¹⁰ In a footnote, Kregel exhumes a correspondence between Minsky and the FDIC Director of the Division of Research and Statistics that shows that it was the FDIC that contacted Minsky to think about “new examination procedures” (Kregel 2014a, 14). It is in this context that Minsky's interest in this subject must be placed.

¹¹ While the reasons are not clearly identified, in mid-September 2019 repossession costs increased very dramatically in the U.S. money market. Several hypotheses on the reasons for this sudden tension have been put forward (tax payments, settlement of government bonds, exit from the QE which has led to a reduction in excess reserves, etc.) without any of them being obvious.

¹² The Basel 1 agreement was thirty pages, whereas Basel 2 was nearly 350 pages. For Basel 3, due to its adoption process in phases, the comparison is less clear-cut. However, the increased regulatory complexity is visible in this increase in the number of pages for the various Basel Committee agreements.

¹³ Large banks’ use of internal control models for regulatory capital is one illustration of this kind of deviation.

¹⁴ Today, the notional value of derivatives contracts remains close to the high amounts of the pre-crisis period, at around $600,000 trillion. See BIS interactive graph https://stats.bis.org/statx/srs/tseries/OTC_DERIV/ H:D:A:A:5J:A:5J:A:TO1:TO1:A:A:3:C

¹⁵ Published in September 2011 in the United Kingdom, the Vickers Report, named after the economist John Vickers, who chaired this independent commission, advocated greater equity and short-term liquidity for retail banks, going so far as to recommend the isolation of retail activities in subsidiaries. The Liikanen Report is a set of proposals for reforming European Union major banks published in October 2012 by a group of European experts led by Erkki Liikanen, then Governor of the Bank of Finland. This report recommended, in particular, the compartmentalization or ‘’ring fencing’’ of trading activities in securities and derivatives, market-making, loans to hedge funds and securitization vehicles, as well as investments in private equity.

¹⁶ In particular, the weighting differences between the IRB and standard models that led the regulator to set up an output floor could be resolved with this single coverage ratio.

Additional information

Notes on contributors

Samba Diop

Samba Diop is an Associate Professor at the Universite de Picardie Jules Verne, CRIISEA, France.