[PassedOut]

I never heard of Hyman Minsky during my college years: it was all Samuelson and his cohorts. But today I read a thought-provoking article in the Boston Globe, and wondered what other posters thought of this: Why capitalism fails

It seems that Minsky has gained in stature among economists recently because he predicted almost exactly what happened last year and why.

Quote

Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers - what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.

Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment - what was later dubbed the “Minsky moment” - would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

But that was last year. I don't see financial institutions becoming conservative this year in the wake of the crash, having learned that the government will (must) provide huge welfare payments as a safety net for large financial institutions when the chickens come home to roost. It does seem, though, that the Fed, together with the Bush and Obama administrations, averted catastrophe by following Minsky's prescriptions.

What intrigued me the most, however, was Minsky's prescription for making capitalism more stable: bubble-up economics -- with a guaranteed job at a good wage available to everyone. I know that this flies in the face of current politics, which holds that welfare payments should be limited to the wealthy and corporations (and especially to large campaign donors), but Minsky argued that bubble-up economics would benefit everyone. He might be as right about that as he was about the recent crash.

[mike777]

"with a guaranteed job at a good wage available to everyone. "

Not sure what this would exactly mean. What job would be guaranteed and by who?
I just wonder if this would mean a loss of privacy and freedom for more security.

For example do I get to pick any job I want and do I get to decide how hard I want to work at it all for a good wage and I could never be fired or would the central government control all of this?

[luke warm]

iirc, minsky did not believe in a gold standard but i could be wrong... it seems to me that his economic theory would benefit from such a standard, however

[Winstonm]

I think you would find the ideas of Ravi Batra of interest. Batra is an professor of economics at SMU and somewhat out of the mainstream, although he has had a number of books on the NYT bestseller list.

"Greenspan's Fraud" addresses stability of economies due to adequate wages and minimum wages.

[benlessard]

I think Winston signature (quote of H. L. Mencken) fit perfectly here.

Quote

"There is always an easy solution to every human problem - neat, plausible and wrong.’” - H. L. Mencken:

[hotShot]

I think the governments were wrong to rescue the banks.
They saved the big predator dinosaurs because they feared the impact their fall might cause, but let the small ones die. Fed from the carrion of the smaller ones and bred by the state those dinosaurs grew even bigger.
If they were to big to fail, what are they now after they grew further?
Freed from a lot of competition, how will they improve?
Yes I know not saving the banks would have been expensive, but looking at the rescue figures, can you say we got of cheap?
And I bet that those bigger banks, learned the lesson off invulnerability an will continue the way they did before.

[helene_t]

I think letting the big banks go bust would have been unacceptable.

I have the idea that the govt's generally payed too much, though. I think the most the govt should have considered offering should have been to take over all assets and liabilities (except for obligations to pay bonuses) of the big banks for zero Euro/$/whatever, if someone else had a better offer than that then obviously the banks were not going bust. And then splitting them up in much smaller units before reprivatising.

Btw I think it's a wrong message to send to savers that they can put their money in high-risk, hi-interest banks and if they fail, the taxpayers will pay. If the problem had been solved by first ribbing off the shareholders and the managers' bonuses and then taking a few percentages of the savers' money, say the current shareholders lose everything and a new share capital is then created by converting x% of the savings to shares, then savers and investors might prefer more responsible banks in the future.

I am probably talking bs, though. It's not clear to me what actually happened.

[mike777]

I am not sure what some posters mean by letting the banks fail, what does that mean, exactly.

I also doubt that people who have checking and savings accounts at their local bank would prefer to just have shares of the new bank but no cash.

If the government did take over the banks, what then, who runs them and how? Running a bank is risky business.

[PassedOut]

mike777, on Sep 23 2009, 09:29 AM, said:

I am not sure what some posters mean by letting the banks fail, what does that mean, exactly.

I also doubt that people who have checking and savings accounts at their local bank would prefer to just have shares of the new bank but no cash.

If the government did take over the banks, what then, who runs them and how? Running a bank is risky business.

Banks fail all the time, but deposits are insured by the FDIC so that bank customers are not wiped out.

Before the depression, people did lose their life savings when banks failed, so the Roosevelt-era government put necessary protections into place. Of course many people at the time felt that this (among many other things) was socialism destroying the US.

But we are the government, and can set things up in a way of our choosing. Assigning labels as a way of promoting or denigrating potential solutions to real problems appeals only to the simple minded. The real question is what works and what doesn't.

It seems to me that Minsky was onto something. He did not portray bubble-up economics as a complete solution to boom-and-bust either, and his approach would bring its own set of problems. But those problems would likely be minor when compared with a depression, or with the actions needed to fend off a depression, such as we had last year and this.

[hotShot]

It's my impression that those banks have become insolvent.
I think there is a procedure how to handle that case.

The value of the bank would drop to 0. The manager bonuses are just a late number if the list of debts of the former bank. If there is not enough to pay all debts, the bonuses won't have to be payed.
And the shareholder would have to take full responsibility and damage for the management the installed and approved.

[kenberg]

A very interesting article. I think I somewhere heard Minsky's name before, but the memory is vague. His learned pessimism fits in with my untutored beliefs.

I think you mis-characterize his bubble up ideas. I didn't see "guaranteed job at a good wage. Here is from the last page of the article

Quote

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

Sweeping streets at minimum wage doesn't has a different feel than "guaranteed job at a good wage".

Human nature is the fundamental problem. There is truth that people tell us, and there is truth that we observe. For some pretty good reasons, we tend to go with the latter. I have claimed, not entirely joking, that the purpose of teenage rebellion is to discover which of the many things adults tell kids are actually true. In later life, these former kids hear about the need for conservative investing and they observe that the risk-takers are getting all the candy. They can spend their time studying the situation, or they look around at what they see, and place a bet.

With teenagers, part of the solution is to keep them from killing anyone else with their antics, and the same applies to the forty-somethings who are screwing around with the financial markets.

[PassedOut]

kenberg, on Sep 23 2009, 10:13 AM, said:

A very interesting article. I think I somewhere heard Minsky's name before, but the memory is vague. His learned pessimism fits in with my untutored beliefs.

I think you mis-characterize his bubble up ideas. I didn't see "guaranteed job at a good wage.

Yes, I shouldn't have morphed "minimum wage" into "good wage."

[helene_t]

kenberg quoting someone else quoting Minsky said:

Minsky, however, argued for [....] The government [....] should become the “employer of last resort,” [..] offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets [.....]

I had the same idea. The European perspective is somewhat different: here, a major concern is that certain forms of unemployment benefits are arguably too generous, in that for people with a low wage it makes more sense to receive unemployment benefit, possibly supplied by cost-saving do-it-yourself work and a little work in the underground economy, rather than having a real job at a wage not much higher than the unemployment benefit. Therefore, receivers of unemployment benefit (or disability benefits, as is the more popular option in the Netherlands) are faced with a monstrous bureaucracy aimed at checking that they really don't work and/or that they are genuinely seeking employment.

If unemployed people got a job as a street cleaner instead of just being payed for doing nothing other than (allegedly) looking for jobs, it would reduce abuse of the system, on top of the other obvious advantages.

Mike777 said:

I also doubt that people who have checking and savings accounts at their local bank would prefer to just have shares of the new bank but no cash.

Sure, but otho taxpayers want some value for their money, rather than bailing out banks.
Btw few if any big banks were heavily insolvent. Suppose you had 10000 Euro on you saving account, now you were left with say 9000, plus some bank shares that might one day be worth something. Most of us would survive that.

[barmar]

kenberg, on Sep 23 2009, 11:13 AM, said:

A very interesting article. I think I somewhere heard Minsky's name before, but the memory is vague. His learned pessimism fits in with my untutored beliefs.

I think you mis-characterize his bubble up ideas. I didn't see "guaranteed job at a good wage. Here is from the last page of the article

Quote

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

Sweeping streets at minimum wage doesn't has a different feel than "guaranteed job at a good wage".

I think you mean "DOES have a different feel".

But how many street cleaners do we need? Then again, if we're already paying these people welfare, we might as well ask them to do something, even if it's redundant work.

One problem is that many people on welfare are single parents. And since they can't afford daycare, they can't work. But if some of these jobs are in government-run daycare, we could offer that as a benefit to all the other people who are working in these government jobs. So instead of having lots of people getting handouts without working, we'll have people getting handouts, some working and the others taking care of all the children to allow the first group to work.

This does seem better, because once someone has a job their self-esteem improves, and they're more likely to look for a better job. If you're totally down and out, you're likely to give up completely.

Does anyone remember "workfare"? I think this was a proposal that people on welfare would have to demonstrate that they're either trying to get work or unable to work. Is this in use anywhere?

[Lobowolf]

barmar, on Sep 24 2009, 12:49 PM, said:

Does anyone remember "workfare"?  I think this was a proposal that people on welfare would have to demonstrate that they're either trying to get work or unable to work.  Is this in use anywhere?

Reminds me of seeing Barry Goldwater on Larry King way back in the day (when Goldwater was only about 150 years old). King asked him about welfare, and the response (probably about 98% complete and verbatim) has stuck with me quite a while:

"A man wants to work and can't, help him.
A man can work and won't, hell with him."

[Winstonm]

The banks that had to be bailed out were NOT the FDIC deposit-taking commercial banks normally thought of. The banks that failed and had to be rescued were Investment Banks - others were insurance companies (AIG) that made bad bets on the I-bank products.

The I-banks went under because of greed and stupidity and regulators (The Fed) who allowed them to stray from their 12-1 leverage to positions as high as leverae of 30-1 (Bear Stearns, Lehman Brothers).

All these bailout did was save the bondholders the loss from risk that they knew they were taking when they bought the bonds in the first place.

[helene_t]

Winstonm, on Sep 25 2009, 12:23 AM, said:

All these bailout did was save the bondholders the loss from risk that they knew they were taking when they bought the bonds in the first place.

Well, Bank of Scotland, Fortis and ABN-AMRO were rescued by govts.

While I see no reason why it should be taxpayers rather than bondholders who pay for the decline in value of the bonds, I think it had merit to save the the financial infrastructure. I would be happy with shareholders losing all their money and savers losing some of their money (I mean, I am less happy with taxpayers compensating them) but as a taxpayer I am also happy to make a sacrifice to ensure that the core function of the banks (facilitating payments) keeps running.

[barmar]

Winstonm, on Sep 24 2009, 07:23 PM, said:

The banks that had to be bailed out were NOT the FDIC deposit-taking commercial banks normally thought of.
...
All these bailout did was save the bondholders the loss from risk that they knew they were taking when they bought the bonds in the first place.

Your first statement is certainly true, but the last is simplistic. Where do you think the commercial banks get their money from? If the I-banks were allowed to fail, there would have been a domino effect.

Or am I naively buying the conventional explanation for the bailout?

[mike777]

To be fair the FDIC banks were in fact bailed out.
The reason given seems to be...we had 24-48 hours to make a decision and that is what we decided/guess was best.

The issue remains was there a better way?


For sake of discussion lets say there was not at that point........

Then the question becomes, why not?


Another question is should we just let non banks, Bear Stearns, FNMA, AIG, etc go bankrupt at that point?

[Winstonm]

barmar, on Sep 25 2009, 08:12 PM, said:

Winstonm, on Sep 24 2009, 07:23 PM, said:

The banks that had to be bailed out were NOT the FDIC deposit-taking commercial banks normally thought of.
...
All these bailout did was save the bondholders the loss from risk that they knew they were taking when they bought the bonds in the first place.

Your first statement is certainly true, but the last is simplistic. Where do you think the commercial banks get their money from? If the I-banks were allowed to fail, there would have been a domino effect.

Or am I naively buying the conventional explanation for the bailout?

The commercial banks do not get their money from the investment banks. In fact, it is the commercial bank that has access to the Fed "Discount Window" and not the Investment Banks. (At least this was the case before the "crisis".)

The systemic risk was that money market funds would "break the buck" - lose money because they had invested heavily in MBS (mortgage backed securities) and the insane Invest Banks like Bear Stearns had leveraged up to 30:1 in the same products.

If the Investment banks were allowed to fail, they would have had to sell off the MBS due to margin calls and at fire sale prices, meaning everyone who owned MBS would have to value their MBS marked-to-market, or at the fire sale price - this would have had a domino effect - and the funds worldwide who held MBS would have been crippled, causing more panic selling snowballing the problem even more.

There is a very real reason why Bill Gross of PIMCO was out pounding the financial talk shows for bailout upon bailout - his company was hugely invested in Fannie Mae MBS and he needed the bailouts to protect his bond investments - he was simply talking his book.