R E S E A R C H O N M O N E Y A N D F I N A N C E

Discussion Paper no 12

A Minsky Perspective on the Global Recession of 2009

Charles J WhalenUtica College, Cornell University School of Industrial and Labor Relations

1 July 2009

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Charles J Whalen, Address: Department of Business and Economics, Utica College, 1600 Burrstone Road, Utica, NY 13502. Email: cjwhalen@utica.edu

This essay was prepared in April 2009 for Minsky, Financial Development, and Crises, edited by Daniela Tavasci and Jan Toporowski (Palgrave, forthcoming).

Research on Money and Finance is a network of political economists that have a track record in researching money and finance. It aims to generate analytical work on the development of the monetary and the financial system in recent years. A further aim is to produce synthetic work on the transformation of the capitalist economy, the rise of financialisation and the resulting intensification of crises. RMF carries research on both developed and developing countries and welcomes contributions that draw on all currents of political economy.

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Abstract

AstheU.S.creditcrunchof2007evolvedintoaglobalrecessioninlate2008 and early 2009, the economic ideas of the late HymanMinskyreceived increasing attention on both sides of the Atlantic Ocean.However, few observers seem to appreciate that about the last dozenyearsofMinsky’slifeweredevoted largelytosynthesizinghisfinancial‐instabilityhypothesis(theinfluenceofKeynes)andhisunderstandingoflong‐termcapitalist development(the influenceofSchumpeter). Tofillthatgap,thisessayoffersaMinskyperspective ontheglobalrecessionof 2009by drawing on the insightsMinsky gained from Keynes andSchumpeter. While the Keynesian and Schumpeterian dimensions ofMinsky’s viewpoint are intertwined intherealworld, thispresentationhighlights the cyclical and structural aspects of the current crisisseparately. After examining the nature and causes of the globaldownturn through those two lenses, Minsky’s policy proposals arecomparedwithstepstakenbytheU.S.governmentthroughApril2009.

1.Introduction OnAugust18, 2007,a front‐pagestory inTheWallStreet Journalhighlighted theideasof

economist Hyman Minsky. With the U.S. economy in the midst of a worsening credit

crunch, reporterJustinLahartobservedthatalthoughMinskydied in1996,hisviewswere‘reverberating from New York to Hong Kong as economists and traders are trying to

understandwhat’shappeninginthemarkets’(Lahart2007).

Since2007, attention toMinsky’sideashas increased as global economic conditionshave

deteriorated(see,forexample,Cassidy2008;Pollin2008;and‘Minsky’sMoment’2009).As

aneconomistwho haslongappreciatedMinsky’sinsights,I am happyto seethisflurryofinterest.YetIfearthatmanyobservershavemissedthefullsignificanceofhiscontributions.

ManyofthosenowontheMinskybandwagontreathisideasasrelevanttounderstandingasingleeconomic event.Market analysts andtraders even referto that event asa ‘Minsky

moment,’ which arrives ‘when over‐indebted investors are forced to sell even their solid

investments tomakegoodontheir loans’ (Lahart2007). Ifthetroublewere tobecomesowidespreadthatitthreatenedthebankingsystematthenationalorinternationallevel,then

somewouldreplacetheword‘moment’with‘meltdown’(Magnus2008).However,thefocusisstillonasingleincident,notontheevolutionarypathofeconomicactivity.

Others exposedtoMinsky’s ideasacknowledge that hisworkwas grounded in adynamic

conception of theeconomy. Formost in this group, though,Minsky’splace ineconomicsrestsonwhathecalledthe“financial‐instabilityhypothesis.’AccordingtoMinsky,capitalist

financial systems tend to cycle endogenously from a conservative state of affairs calledhedgefinancing,toamoreriskyformcalledspeculativefinancing,toanunsustainableform

calledPonzifinancing,andthenbacktohedgefinancingforanotherround.Thispatternof

economicactivitytendstogenerateaseriesofboomsandrecessions,andtheseverityofthelatter depends largely on the effectiveness of government regulation and stabilization

policies(Minsky1982;1992a).

AfullappreciationofMinsky’sinsights,however,mustrecognizethataboutthelastdozen

yearsofhislifeweredevotedlargelytosynthesizingthefinancial‐instabilityhypothesisand

anunderstandingof long‐term capitalistdevelopment.Indeed, in an essaywritten forthehundredth anniversary of the birth of John Maynard Keynes and Joseph Schumpeter,

Minskywrote: ‘The task confronting economics todaymay becharacterized as a need tointegrate Schumpeter’s vision of a resilient intertemporal capitalist process with Keynes’s

hardinsightsinto thefragilityintroducedinto thecapitalistaccumulationprocessbysome

inescapable properties of capitalist financial structures’ (Minsky 1986a, 121). A keyconclusionofMinsky’spursuitofsuchasynthesisisthatalthoughthe ‘basicpath’ofreal‐

worldcapitalism iscyclical (Minsky1975,9), the ‘money‐managercapitalism’ characteristic

ofrecentdecadesdifferssubstantiallyfromthe‘managerialcapitalism’foundintheUnitedStatesimmediatelyafterWorldWarII(Minsky1990a;1993a).Asuccessfuleconomicpolicy

forthepresenteramustbebuiltuponrecognitionoftheinstitutionalfeaturesofthisstage

ofcapitalistdevelopment(MinskyandWhalen1996‐1997).

ThischapteroffersaMinskyperspectiveontheglobalrecessionof2009bydrawingonthe

insights Minsky gained from both Keynes and Schumpeter. While the Keynesian andSchumpeterian dimensions ofMinsky’s viewpoint are intertwined in the real world, the

cyclicalandstructuralaspectsofthecurrentcrisisarehighlightedseparatelyintheanalysis

thatfollows.Afterexaminingthenatureandcausesoftheglobaldownturnfromthosetwolenses,Minsky’spolicyproposalsarecomparedwith recent policy steps takenbytheU.S.

government.

2.CyclicalDynamics

Minsky’s financial‐instability hypothesis can be seen as an alternative to the ‘efficient‐market hypothesis’ of conventional economics. According to that conventional view,

investors,lendersandotherfinancial‐marketparticipantsarenot,asagroup,predisposedtooverconfidence or other biases (Shefrin 2000, 4). In contrast, the financial‐instability

hypothesistreatsoverconfidenceandpanicsasregularfeaturesoftheeconomiclandscape.

MinskytracesthisaspectofhisperspectivetoKeynes,especiallytothelatter’s1937articleinTheQuarterly Journal of Economics, ‘TheGeneral Theory ofEmployment’ (Minsky 1975,

64‐67; Keynes 1937). In that essay, Keynes describes his departure from the mainstreameconomicsofhistime,whichhecalled‘classical economictheory,’ asthedeparturefroma

focusonlong‐periodequilibrium(Keynes1937,213‐214).Behindboththeclassicaltheoryof

Keynes’s timeand the efficient‐market hypothesis of our own is an assumption that thefuture can be treated as a matter involving risk (reducible to the calculation of

probabilities), not uncertainty. Keynes, however, dismisses this substitution of risk foruncertaintyinthecaseofmosteconomicanalyses:

Thewholeobjectoftheaccumulationofwealth isto produceresults,orpotential

results,at acomparativelydistant, andsometimes at an indefinitelydistant,date.Thusthe fact thatourknowledgeofthefuture isfluctuating,vagueanduncertain

renderswealthapeculiarlyunsuitablesubjectforthemethodsofclassicaleconomictheory.Thistheorymightworkverywell inaworldinwhicheconomicgoodswere

necessarily consumed within a short interval of their being produced. But it

requires,Isuggest,considerableamendmentifitistobeappliedtoaworldinwhichthe accumulation of wealth for an indefinitely postponed future is an important

factor; andthegreatertheproportionatepart playedbysuchwealth‐accumulationthemoreessentialdoessuchamendmentbecome(Keynes1937,213).

According to Minsky, the financial structure of our economy becomes more and more

fragile overa periodofprosperity. In theearly stages ofprosperity, enterprises in highlyprofitablesegmentsoftheeconomyarerewardedfortakingonincreasingamountsofdebt.

Andtheirsuccessencouragesotherfirmstoengageinsimilarbehavior.

Thispatternwascertainlyevident inthehigh‐techsectorduring thelate1990sandinthe

housing sector during the early‐ and mid‐2000s. In fact, construction companies and

contractorswerenottheonlyonestakingonmoredebtinthe2000s.Homebuyerswerealsotakingonmoredebtasthehousingmarketbeganheatingup,inpartbecauseinterestrates

werelowandthestockmarkethadbecomelessattractiveinthewakeofthedot‐comboomand bust. While it had long been customary for U.S. homebuyers to make a 20‐percent

downpaymentonahome,42percentoffirst‐timehomepurchasersand13percentofbuyers

whowerenotfirst‐timepurchasersputnomoneydowntoacquirehomesinthemid‐2000s(Baker2009a;Max2005;Irwin2005).1

In retrospect, it seems that enterprisesandhomebuyersshouldhaveresisted the impulsetowardincreasingindebtedness,buttheincentivesatthetimewerejusttoogreat.AsGary

DymskiandRobertPollinexplainina1992essay,nobodyinarobustsectoroftheeconomy

wantstobeleftbehindduetounderinvestment:

EvenifmarketparticipantsdidhavefullknowledgeoftheMinskymodel,andwere

awarethatfinancialcriseswilloccuratsomepoint,thatwouldstillnotenablethemto predict when the financial crisis will occur. In the meantime, aggressive firm

managers and bank loan officers will be rewarded for pursuing profitable

opportunities and gaining competitive advantages. Cautious managers, operatingfromtheunderstandingthatboomconditionswillendatsomeuncertainpoint,will

be penalized when their more aggressive competitors surpass their short‐runperformance(DymskiandPollin1992,45).2

As the preceding quote indicates, lenders as well asborrowers fuel the tendency toward

greater indebtedness in an expansion. The same climate of expectations that encouragesborrowerstoacquiremoreriskyfinancialliabilitystructuresalsoeaseslenders’worriesthat

new loans might go unpaid (Minsky 1975). Moreover, it is not just that borrowing andlending expand in the boom. There is also financial innovation. In fact, in a 1992 essay,

Minskywrotethatbankersandotherfinancial intermediariesare ‘merchantsofdebt,who

strive to innovate with regard to both the assets they acquire and the liabilities theymarket’(Minsky1992a,6).

Theboomcannotcontinueforever,however;weeventuallyarriveatwhatsomehavecalledthe‘Minskymoment’(Lahart2007,1).Inotherwords,iteventuallybecomesclearthatsome

borrowers have become overextended and need to sell assets (or secure a government

bailout)tomaketheirpayments.Inthecurrentcrisis,earlyhigh‐profilecases involvedthemortgagebrokerCountrywide,theBritishbankNorthernRock,andtwohedgefundsrunby

BearStearns (Stempel 2007;Reckard,Douglass andPetruno 2007; LarsenandGiles 2007;Mildenberg2008;Foley2007).3

Then the problem spreads. Since bankers and investors hold subjective views about

acceptable debt levels, once a shortfall of cash and a forced selling ofassetsmaterializessomewhereintheeconomy,it canleadtoawidespreadreassessmentofhowmuchdebtor

lending isappropriate.Moreover, thebuildupcangoonforyears,butwhenanythinggoeswrongtherevaluationcanbesudden(Minsky1982,67).

Whenbanksdecidetoreinintheirlending,wefindourselvesinacreditcrunch.Itiseasyto

think of the present economic crisis as something that beganwith theworldwide stock‐market downturn in the autumn of 2008. In fact, though, the difficulties of 2008 were

preceded by a credit crunch that began in the summer of 2007, and signs of trouble—traceableinlargepartto the‘subprime’mortgagemarket—wereevidentasearlyasMarch

2007(Magnus2007;Foley2007;‘Timeline’2009).

Onceacreditcrunchemerges,financialdifficultiesarenolongerconfinedtoonesector.Infact,acrunchthreatensnotonlybusinessinvestment,butalsohouseholdspending.Thismeansthat

whenasectoralbubblebursts—inthehigh‐techsectornearlyadecadeagoorinthehousingsectormorerecently—thecollapsethreatenstotriggeraneconomy‐widerecession.

AndthatsortofrecessioniswhattheUnitedStatesandmuchoftheworldnowexperiences.

Moreover, it isprettyclearthesituationhasgonebeyondaMinsky‘moment’ andismoreakintoaneconomic‘meltdown,’atleastwithrespecttoU.S.housing,banking,andstocks.

TheDow Jones industrial average, for example, fell 37 percent between April 1, 2007 andApril1,2009(YahooFinance2009).Meanwhile, theU.S.unemploymentraterosefrom 4.4

percentinMarch2007to8.5percentinMarch2009(thelatestmonthlydataavailableasof

thiswriting),andiswidelyexpected tocontinuerising through2009(U.S.DepartmentofLabor2009;‘Obama’seconomicaideseesrisingU.S.unemployment’2009).

3.StructuralEvolution

In a pair of articles designed to integrate key contributions of Keynes and Schumpeter,

Minsky mentions that Keynes and institutionalist Wesley C. Mitchell had a commonperspective on business cycles (Minsky 1993a; 1990a). Bringing Mitchell into the picture

helpsunderscorethesortofsynthesistowardwhichMinskywasaiming:Mitchellhadlongagowrittenthat ‘eachnewcyclepresentsidiosyncrasies.Businesshistoryrepeatsitself,but

alwayswithadifference’(Mitchell 1941,ix). Inthe1990s,MinskystillbelievedthattheU.S.

economymoves along a cyclical path, but he also believed that the system had recentlyentered a new stage of capitalist development. Themanagerial era that matured in the

immediate aftermath of World War II had, during the 1980s, given way to a stagecharacterized by emergence of money managers as the nation’s dominant economic

decision‐makers(Minsky1990a;1993a;1996;seealsoWhalen2001and2002).

WhileKeynesofferedinsightsinto cyclical fluctuations,Schumpeter(Minsky’sdissertationadvisor at Harvarduntil the relationshipwas cut short by Schumpeter’s untimely death)

providedMinskywithinsightsinto structuraleconomicevolutionoveraseriesofcycles.Infact,MinskyunderscoredanaspectofSchumpeterian‘creativedestruction’ that fewothers

recognized: ‘Nowhere are evolution, change and Schumpeterian entrepreneurship more

evident than inbanking andfinanceandnowhere isthedriveforprofitsmoreclearlythefactormaking for change’ (Minsky1993a, 106).Thus, fourinstitutional featuresofmoney‐

managercapitalismemergetoplayaroleinexplainingtheeconomicdifficultiesofthepastfewyears.Theoriginofthecurrentglobal crisiscanbetracedinlargepartto thefollowing

financial‐sector innovations: unconventional mortgages, securitization, the rise of hedge

funds,andtheglobalizationoffinance.

At the heart of the current financial crisis are home mortgages that deviate from the

traditional U.S. home‐loan arrangement, which involved a long‐term loan on fixed‐rateterms. Many of these unconventional—some have even called them ‘exotic’—mortgages

haveadjustableinterestratesand/orpaymentsthatballoonovertime.Federal lawallowed

banks to issue adjustable‐rate mortgages since 1982, but their use and complexity haveexplodedinthepastdecade.Forexample,industryexpertsestimatethatavariantcalledthe

‘optionadjustable ratemortgage’ (optionARM),which offers a low ‘teaser’ rate and laterresets so thatminimum payments skyrocket, accounted forabout 0.5 percent of all U.S.

mortgages written in 2003, but close to 15 percent (and up to 33 percent in many U.S.

communities) in2006.More precisefigures are unavailable because bankshavenotbeenrequiredtoreporthowmanyoptionARMstheyoriginate(DerHovanesian2006).

Many of these mortgages were created to target less‐creditworthy customers, includingthoseinwhatthebanking industrycalls thesubprimemarket (Baker2009a).Otherswere

marketedto peoplewhowanted tospeculate intheboominghousingmarket,peoplewho

intended to buy and then quickly resell property. However, many unconventional loanswere marketed to ordinary working families who could have handled conventional

mortgages(Marks2008).

Unfortunately,itwasclearfromtheoutsetthatmanyoftheseexoticmortgagescouldneverbe paid back. (For an eye‐opening look at the aggressive marketing of unconventional

mortgages,seeMorgenson,2007).Butwhydidthishappen?Whydidthemortgagemarket

evolveinthisdangerousdirection?

Thisiswheresecuritizationcomesintothepicture.Securitizationissimplythebundlingof

loans—which can include auto loans, student loans, accounts receivable, and, of course,mortgages—and the subsequent selling of bundle shares to investors. In the mid‐1980s,

MinskyreturnedhomefromaconferencesponsoredbytheFederalReserveBankofChicago

andwrotethatsecuritizationwasemergingasakey,newfinancialinnovation. ‘Thatwhichcanbesecuritized,willbesecuritized,’ hewrote(Minsky1990a,64).Hewasright,butway

aheadofhistime.Securitizationofmortgagesexplodedontothesceneinthepastdecade.

Afterthedot‐combubbleburstin2001,housingintheUnitedStateslookedlikeasaferand

moreattractiveinvestment thanevertomanyAmericans,especiallywithlowinterest rates

in placedueto Federal Reserve policy. Still, returns on conventionalmortgageswere toomundane to satisfy the aims of most money managers. As a result, what Minsky and

Schumpeter might have called the ‘financial‐innovationmachine’ turned its attention tohousingandshiftedintohighgear.

Securitizationofmortgagesmeantthathomeloanoriginatorscouldbelessconcernedabout

the creditworthiness ofborrowers than in the past. Thus, theyhad an incentive to steercustomers toward themost profitable types ofmortgages, even if they were the riskiest

(which,ofcourse,theywere)(DerHovanesian2006).TheresultwastheexplosivegrowthinoptionARMs and in ‘nomoneydown’ and ‘no documentation(of income)’ loans.Minsky

warnedofallthisin1992,whenheobservedthatsecuritizationmeansmortgageoriginators

arerewardedaslongastheyavoid‘obviousfraud’(Minsky1992b,22‐23).4

Securitizationworkedlikemagicuponriskymortgages.Insteadof‘garbagein,garbageout,’

risky loanswent into theprocess, butout came bundles that receivedhigh credit ratingsfromagencies likeStandardandPoors.AccordingtoChristopherHuhne,amemberofthe

BritishParliamentandformerrating‐agencyeconomist,part of thechallengeofrating the

bundleswas‘that financialmarketsfall in lovewithnewthings,with innovations,andthe[important] thingaboutnewthingsis that it isverydifficultto assess the realriskinessof

thembecauseyoudon’thaveahistorybydefinition’(Huhne2007).

Another problem is that the rating agencies do not verify the information provided by

mortgage issuers. Instead, they base their decisions on information received from

intermediariesthat, asMinskyput it, ‘do not hazardanyoftheirwealthonthe long termviabilityoftheunderlying[loans]’(Minsky1992b,23).

Moreover, thereare somanymiddlemenin themortgage securitizationgame, includinganumber permitted to operate in a largely unregulated manner, that no one person or

organization canbeeasilyassignedblame in theevent ofdefault.Thechainbetween the

borrowerandtheinvestorincludesrealtors,homeappraisers,mortgagebrokers,mortgageoriginators,investmentbanksthatbundledthemortgages,agenciesthatratedthebundles,

andevencompanies(likeAmericanInternationalGroup) that insuredmanyofthebundles(Whalen2008a,235).5

Trillionsofdollarsworthofmortgage‐backedsecuritieswerebundledandsoldassharesto

investors. Inlate 2008,FannieMaeandFreddieMacaloneheld $4.1 trillion (LanmanandKopecki 2008). Moreover, the private market in credit default swaps—used as a hedge

against(mortgage‐backed)securitieslosses,asawaytospeculatethatothercompanieswillexperiencealoss, orasanarbitrage instrument—reached$45trillionbylate2007(O’Hara

2009,14).

Manyofthemortgagesunderlyingmortgage‐backedsecuritiesarenowinforeclosureorareheadedthere.In2008,2.3millionU.S.homeswentintoforeclosure,up81percentfrom2007

and225percent from 2006(RealtyTrac2009a). Therewereanother803,489filings in thefirst quarterof2009(themostrecentperiodforwhichdataareavailableas thischapteris

beingwritten),up9percentfromthepreviousquarter(RealtyTrac2009b).

Mortgage delinquencies are also up sharply. In February 2009, 7 percent of U.S.homeownerswithmortgageswereat least30dayslateontheirloans,an increaseofmore

than50 percent fromayearearlier.Amongsubprimeborrowers,thatmonth’sdelinquencyratewas39.8percent(Chernikoff2009).6(Again,thesearethelatestavailablefigures.)

Therehasbeenmuchpublicdiscussionoverthepastyearorso intheUnitedStatesabout

recklesshomebuyers,butmortgageseekersalonecouldnotanddidnotbringtheeconomyto itskneeson theirown.Exotichome loans andmortgage securitizationareproductsof

money‐managercapitalism.AsMinskystressedat apairofprofessionalconferences inthelate 1980s and early 1990s, there is a symbiotic relationship ‘between the growth of

securitization and managed money.’ Fund managers, he argued, ‘have outgrown the

orthodoxhighqualitystockandbondportfoliosoffiduciaries’(Minsky1990a,71;1992c,32).

FromaMinskyperspective, theeconomicparticipantsmostresponsibleforbringingdown

the economy are hedge funds and other investment funds, investment banks, andotherfinancial institutions.Lookingathedgefundsoffersaglimpseatwhathappened.Although

thefollowingdiscussionfocusesonhedgefundsbecausetheyarearelativenewcomertothe

scene and have become infamous for operating beyond the reach of much governmentregulation, the investment banks and other institutions played a similar role (and since

1999, U.S. banking has operated without the Glass‐Stegall firewall that separatedcommercialandinvestmentbankingforoverahalfcentury).

Someofthebiggestpurchasersofsecuritizedmortgageshavebeenhedgefunds.Theearliest

ofthesefundswereestablishedinthefirstfewdecadesafterWorldWarIIforthepurposeofseekingabsolutereturns(ratherthanbeatingabenchmarkstock‐market index).Theywere

indeed ‘hedged’ funds, which sought to protect principal from financial loss by hedginginvestments through short selling or othermeans. The numberof hedge funds and the

assets undertheirmanagement expanded in the1990sandgrewevenmorerapidlyin the

2000s.At thesametime, theseassetsbecameincreasingly concentratedat thetop10 firmsand funds becamemore diverse in terms of the strategies their managers employed. In

mid‐2008, theAlternativeInvestmentManagementAssociationestimated that theworld’shedgefunds (basedprimarily intheUnitedStates) weremanaging $2.5 trillion, though it

acknowledged that other estimates were as high as $4 trillion (Ineichen and Silberstein

2008,16).

Thetotalvalueofassetsunderhedge‐fundmanagementisuncertainbecausesuchfundsare

typicallyrestrictedtowealthy individualsandinstitutional investors,whichexempts themfrommostfinancial‐sectorreportingrequirementsandregulation.Takingadvantageoftheir

largelyunregulatedstatus,managersofhedgefundsusedtheirmortgage‐backedsecurities

as collateral to take out highly leveraged loans. They then purchased an assortment offinancial instruments,includingstillmoremortgagebundles.Asaresult,theworld’shedge

funds used securitized mortgages to lay an inherently flimsy foundation for a financial‘houseofcards’(Freeman2009;Holt2009).

Thecurrentcrisisisunmistakablyglobal.It ishavingeconomicandpoliticalramifications

onall continents(‘Timeline’ 2009;Whalen2009).ThetroubleisevenaffectingunexpectedplaceslikeruralChina:factoriesincitiesalongthatnation’scoastarelaying‐offworkersand

sendingthembacktotheirvillages(Lee2009).

Theglobalnatureof thecurrent situationwouldnothavesurprisedMinsky,who stressed

earlyonthatmoney‐managercapitalism‘isinternationalinboththefundsandtheassetsin

funds’ (Minsky1990a,71).Lookingaheadtothecurrent crisis,Minskywrote: ‘Theproblemof finance that will emerge is whether the … institutions of national governments can

contain both the consequences of global financial fragility and an international debtdeflation’ (Minsky1995,93).HeworriedthattheUnitedStateswouldbeunableto serveas

‘the guardian angel for stability in the world economy’ and stressed the need for ‘an

international division of responsibility for maintaining global aggregate grossprofits’(Minsky1986b,15;1990a,71).

Inshort,theglobaleconomyisnowreelingfromtheconsequencesofaclassicMinskycrisis.Its origins are in a housing boom fueled by rising expectations, expanding debt, and

financial innovation.Then thebubble burst, creatingfirsta creditcrunch, then abroader

bankingandstock‐marketcrisis,andnowarecession.

The consequences have been staggering. In thehousing sector, an unprecedented one in

nineU.S.homes (14million) sitsvacant, while another9.4million are forsale (ElNasser2009).TheU.S.stockmarketlostanunprecedented$1.2trillionofvalueinjustasingleday

inlateSeptember2008(measuredbytheWilshire5000),andfor2008overalltheDowJones

industrial averagehad itsworst yearsince 1931 (Twin2008; Blaine2008).Unemploymentmay soon hit doubledigits in theUnited Statesandhas alreadyreacheddouble digits in

somepartsofEurope(Eurostat2009).

Since 2007, the global banking industry has seen an unprecedented shakeout (‘Timeline’

2009),butthereisstilluncertaintyabouthowmuchmoredifficultyliesahead.AstheBank

forInternationalSettlementsindicatedinareportreleasedinJune2007:

Assuming that the big banks have managed to distributemorewidely the risks

inherent in the loans they havemade, who now holds these risks, and can theymanagethemadequately?Thehonestansweristhatwedonotknow.Muchofthe

risk isembodiedinvarious formsofasset‐backedsecuritiesofgrowing complexity

andopacity.Theyhavebeenpurchasedbyawiderangeofsmallerbanks,pensionfunds, insurance companies, hedge funds, other funds and even individuals, who

have been encouraged to invest by the generally high ratings given to theseinstruments(BankforInternationalSettlements2007,145).

WarrenBuffettmadethepointmorevividly:‘Youonlylearnwhohasbeenswimmingnaked

whenthetidegoesout’ (Buffett2008,3).Althoughtherisksarenowbeinglaidbare,itwillstillbesometimebeforetheworldlearnsthefullextentofthefinancialexposure.

4.PublicPolicy

The current global economic situation requires a two‐pronged economic‐policy strategy:

recoveryand reform. Beyond stabilizing the troubledfinancial sector and preventing thecurrent downturnfrombecomingmore severe, theoverarching policyobjectiveshouldbe

greatermacroeconomic stability and broadly shared prosperity in the United States andabroad(Minsky1986c;MinskyandWhalen 1996‐1997).Thissectionhighlightssomeofthe

most important policy issues by comparingMinsky’s recommendations with recent U.S.

governmentaction.7

4.1Recovery

A government strategy for recovery must have at least three components: fiscal policy,

monetarypolicy,andfinancial‐marketpolicy.Eachisconsideredinturn.

ThefoundationofMinsky’sstrategyforavoidinganotherGreatDepressioniswhathecalls‘Big Government’ (Minsky 1986c, 292‐308). At the heart of Big Government is a federal

budget that tendstowardsurplusesin inflationaryperiodsand that producesdeficitslargeenough to stabilize aggregate profits in recessionary periods. Minsky stressed that such

countercyclical spendingshouldbea ‘built‐in’ featureof thebudgetstructure,buthealso

recognizedthatdiscretionaryactionwouldbeneededonoccasion(Minsky1986c,132,292).

Sincethemid‐1970s,however,policymakershaveallowedtheautomaticstabilizingfeatures

oftheU.S.federalbudgettoerode.AsacolleagueandIdemonstratedinlate2002,incometaxes,unemploymentinsurance,welfareexpenditures,andtheminimumwagehavealllost

muchoftheirabilitytoserveascountercyclicalmechanisms.Weconcluded:‘Itmakessense

to shore up the economy’s fiscal stabilizers. Better to fix the roof before the rainbegins’(WhalenandWenger2002,91).Bythetimethestormfinallyhit,however,littlehad

changed.

Theerosionofautomaticstabilizershasforceddiscretionarymeasuresto doall theheavy

lifting. In thecurrent downturn,fiscalpolicy in theUnitedStateshasmovedin theright

direction,buttheinitiativeshavebeentootimid.Thefirststimulusattempt,passedinearly2008, included $100 billion in tax rebates and provided a modest boost to consumer

spending (Broda and Parker 2008), but the bill also included tens of billions in lessstimulative business tax cuts.More recently, President Barack Obama signed into law a

stimuluspackagetotaling$787billionovertwoyears.However,PaulKrugmanwasprobably

correctwhenhesuggestedthepackageshouldhavebeentwiceasbigandevenmoretiltedtowardspending(asopposed to taxcuts),especially since recentdata revisionsshowthat

fourth‐quarterU.S.grossdomesticproductfell by6.3percent,not4.0percent asreportedoriginally(Earnshaw2009;Krugman2009a).8

BeyondgivingamajorroletothefiscalpolicyofBigGovernment,Minskystressedthatthe

central bank must interveneas lender‐of‐last‐resort in response to the threat of a seriouscredit crisis and economiccontraction. ‘Central banksarethe institutions responsible for

containingandoffsettingfinancialinstability,’hewroteinStabilizinganUnstableEconomy,publishedin1986(Minsky1986c,322).Inthatsameyear,Minskyalsocontributedanarticle

emphasizing the globalization of finance and the need for international central‐bank

coordinationtoprepareforthenextbigfinancialcrisis(Minsky1986b).

FromaMinskyperspective,monetary policyhas largely beenon theright track since thecredit crunch hit in mid‐2007. In an effort to stabilize the financial sector and overall

economy, theFederal Reservehasaggressivelycut interest rates,allowedbanksto borrow

from it atnominal rates,andgiven bankscash in exchangefor riskyassets(promising totakeontherisk ifthoseassetsproveworthless).9TheFedhasalsoengineeredbankmergers

andworkedwithothercentralbanksto increasethesupplyofdollarsworldwide.Inaveryshorttime,FedchairmanBenBernankehasmovedalongwayfromthedayswhenhewas

knownasaproponentofinflationtargeting.10

In contrast, financial‐market policy at the U.S. Treasury Department has been woefullyinadequate from a Minsky vantage point. The Troubled Asset Relief Program, more

commonlyknownas the$700 billionWall St. Bailout, seemeddesigned to cleanupbankbalancesheetsbypurchasingtheirbadassets.Instead,theTreasurywassoonwritingbanks

checks andbuying largequantities of bank stocks. The underlying problem of the ‘toxic’

assets remained unresolved, banks remained reluctant to lend, and much of the addedliquiditywastransformedintobankstockdividends.

TheTreasury’s latest plan, a‘public‐privatepartnership’ thatcreatesamarket fortroubledassets with government loans and guarantees, is not much better. The plan offerswhat

JosephE.Stiglitzcallsa‘win‐win‐loseproposal:thebankswin,investorswin—andtaxpayers

lose.’Hearguestheplanencouragesinvestorstobidhighinthatnewlycreatedmarketandsocializes the losses that are likely to follow. In attempting to account for thisproposal,

Stiglitzwrites:‘Perhapsit’sthekindofRubeGoldbergdevicethatWallStreetloves—clever,complex and nontransparent, allowing huge transfers of wealth to the financial

markets’(Stiglitz2009).

A different approach would likelyhavebeenendorsedbyMinsky, who admiredhow theadministration of President Franklin D. Roosevelt closed insolvent banks and assisted

solventonesduringtheGreatDepression.Minskywouldhavealmostcertainlycalledforamorehands‐onsorting‐outofthecurrentfinancialmessbymeansofbankrestructuring.

Today,Krugman(2009b;2009c),DeanBaker(2009b),andJamesK.Galbraith(2009)callfor

similaraction.Forexample,Galbraithwrites:‘Ifthesubprimesecuritiesaretrulytrash,mostof thebigbanksaretroubledandsomeareinsolvent. TheFDICshouldputthemthrough

receivership,get cleanaudits, install newmanagement, andbegin thenecessaryshrinkageofthebankingsystemwiththebigguys,notthesmallones’(Galbraith2009).TheObama

administration recently ordered federal regulators to conduct ‘stress tests’ to gauge the

conditionofthenation’sbanks.Asanextstep,thereceivershipapproachmakesmoresensethancreationofagovernment‐subsidizedmarketfortoxicassets.

Another aspect of financial‐market policy that currently needs attention involves homemortgages.Throughout2008,theUnitedStateslargelyavoidedaddressingtheunaffordable

mortgages that are at the heart of the current problem (Marks 2008). The Obama

administrationhasbeenencouragingthefinancial industrytovoluntarilyrestructurethoseloans, but industrypressurehasmademany inthenation’scapital reluctant to requireit.

Forexample,federal legislatorshavesofarrefusedto letbankruptcyjudgesinsistonhomeloan restructuring, despite the fact that judges can demand a restructuring of all loans

exceptthemortgageonahomeowner’sresidence(legislationisstalledintheU.S.Senateas

ofthiswriting).AlthoughMinskydidnotaddressthisproblemdirectly,hisinterestinsocialjusticeandahumaneeconomysuggesthewouldhaveinsistedthatthisproblemberesolved

by mortgage restructuring and would have been incensed that the problem has beenunresolvedforsolong(Minsky1986c;Minsky1993b).

4.2Reform

Lookingbeyondthecurrentdownturn,areformagendamustincludestricterregulationandsupervision of the financial system, a national commitment to the challenges facing

America’s working families, and U.S. participation in efforts that promote internationaleconomicstabilityandjobcreation.

Minskybelievedthat those responsible forgovernment regulation and supervisionof the

financialsystemwereina‘never‐endingstruggle’withfinancialmarkets(Minsky,quotedinPhillips1997,512).AshewroteinStabilizinganUnstableEconomy,‘Afteraninitialinterval,

thebasicdisequilibratingtendenciesofcapitalistfinancewillonceagainpushthefinancialstructureto thebrinkoffragility.’ Still,hebelieveditwasnecessaryfortheFederalReserve

andregulatorstocontinuethestruggle:‘Theevolutionoffinancialpracticesmustbeguided

to reduce the likelihood that fragile situations conducive to financial instability willdevelop’(Minsky1986c,322,333).

Today, thoseadopting aMinsky perspectivewould hold the sameview. Greaterindustrytransparency,morerigorousbankexaminations,andbroaderregulatoryoversightwouldbe

a good place to start. If policymakers had better information about the extent to which

financial institutions were making use of option ARMs and other exotic instruments,perhaps at least a few would have more aggressively sought to address the mounting

problem. It also seems appropriate to reviveMinsky’snotion of acash‐flow approach tobank examinations,which ‘wouldusetheexaminationprocess togenerate informationon

not onlytheliquidityandsolvencyofparticular institutions,butalso on threats,ifany,to

thestabilityoffinancialmarkets’(Minsky,quotedinPhillips1997,513).Similarly,mortgagebrokers,hedgefunds,andotherinstitutionsthathavegainedincreasingimportanceinthe

past decade deserve greater scrutiny from financial‐system regulators.11 In light of the

current economic crisis, stricter oversight of securitization and other recent financialinnovations are clearly overdue, but the additional need is for regulators to be on the

lookoutforfutureinnovationsinanefforttohead‐offpotentialcrisesbeforetheyoccur.

At the very least, theU.S.government shouldnot block state efforts designed to protecttheir citizens from gaps in federal law. Today, most Americans know about the 2008

Valentine’sDayinWashington that cost formerNewYorkGovernorEliotSpitzerhis job,butofgreaternationalimportancewashisguestcolumnthatappearedinTheWashington

Post thatday.Itdescribedhowthefederalgovernmentstoppedstatesfromcrackingdown

on predatory lending practices. As Spitzer’s essay documents, ‘Not only did the Bushadministration do nothing to protect consumers, it embarked on an aggressive and

unprecedented campaign to prevent states from protecting their residents from the veryproblems to which the federal government was turning a blind eye. …The tale is still

unfolding,butwhen thedust settles,[theBushadministration]willbejudgedasawilling

accomplicetothelenderswhowenttoanylengthsintheirquestforprofits’(Spitzer2008).

Intheageofmanagerialcapitalism(approximately1935‐1982),itmayhavebeensufficientto

focusonfull employment, lowinflationandsteadyeconomicgrowth.Intheageofmoney‐managercapitalism (since 1982), these goals are still important, but thechallengesfacing

America’sworking families requiremoredirect attentionaswell. Americans, like citizens

elsewherearoundtheworld,wanttheopportunitytodevelopandutilizetheirtalentsandtoincrease their standard of living in theprocess. They also want the prospect of an even

betterlifefortheirchildren.

Unfortunately,risingworkerinsecurityistheflipsideofmoney‐managercapitalism.Under

pressurefrommoneymanagers, corporateexecutiveshavelargelyputaside theemployer‐

employee social contract of theNewDeal andthe early decades followingWorldWar II.Employers have moved increasingly toward treating labor as just another ‘spot market’

commodity (Minsky 1996; Minsky and Whalen 1996‐1997; Whalen 1997; Whalen 2008bZalewski2002).

Thus, theeconomic challenges facing theUnitedStatesextendfarbeyondstabilizing the

financial systemandpreventingalonganddeeprecession,asMinskyandIdiscussedinanarticlewrittenshortlybeforehisdeath(MinskyandWhalen1996‐1997).Thenationneedsto

spur the growth of domestic jobs that pay family‐supporting wages and to ensure thatAmericans have access to the education and training such jobs require (Marshall 2010;

GloverandKing2010).Itneedstofindawaytopromotepartnershipsbetweenworkersand

managers, so companies can compete on the basis of innovation, quality, and customerservice,ratherthanbyoutsourcingjobsorslashingwagesandbenefits. Itneedstoprovide

adjustmentassistancetoworkersdisplacedbyinternationaltrade(includingserviceworkers

excluded from some existingbenefits programs) andpublic‐service employment to thoseunable to find private‐sector work. And it needs health‐care reform, retirement‐system

reform,andlabor‐lawreform to addressmedical insecurity, retirement insecurity,andthe

insecurityofworkerswho seek to exercise their legal right to engagein unionorganizingandcollectivebargaining(Whalen2008b;2008c).

ToaddressthechallengesfacingAmerica’sworkingfamilies,theObamaadministrationhascreatedaMiddleClassTaskForce,headedbyVicePresidentJoeBiden.Itsgoalssuggestan

awarenessoftheissuesjustmentioned(‘AbouttheTaskForce’2009).Yetonlytimewilltell

whethertheadministrationdevotesmuchattentionandresourcestotheseissues.

Finally, pursuit ofgreatereconomicstabilityandbroadlysharedprosperitycannot end at

the borders of the United States. Indeed, as suggested above, Minsky recognized thatmoney‐manager capitalism is worldwide in scope andthat stabilization anddevelopment

challengesmustbeaddressedatagloballevel.FromaMinskyperspective,Americansmust

helpfashioninternational institutionsthatnotonlycontainglobalfinancialinstability,butalsoenhancelaborrightsandpromotejobgrowth(Minsky1995;1993a;1990b;1986b;Palley

1999,55).

The world’s key policymakers, however, have been reluctant to move in this direction.12

Indeed,internationaleconomicpolicyhasbeendominatedbyadifferentoutlook,asStiglitz

indicatedafterservingattheWorldBank:

Duringmythree years as chief economist oftheWorldBank, labormarket issues

werelookedatthroughthelensofneoclassicaleconomics. ‘Wagerigidities’—oftenthefruitsofhard‐foughtbargaining—werethoughtpartoftheproblemfacingmany

countries.Astandardmessagewas toincreaselabormarketflexibility.Thenot‐so‐

subtlesubtextwasto lowerwagesandlayoffunneededworkers(Stiglitz,quotedinKomisar2000).

Stiglitz concluded, ‘Theyhad a strategy for jobdestruction. They hadno strategy for jobcreation’ (Stiglitz, quotedinKomisar2000).EconomistswhoseetheworldfromaMinsky

perspectiveneedtocollaboratetodevelopthatmissingstrategy.

5.Conclusion:StandingontheShouldersofMinsky

Minskyusedto say weshould stand on the shouldersofgiants to betterunderstand theeconomy.JustashestoodontheshouldersofKeynesandSchumpeter,wecannowstandon

his shoulders to understand and address the current global recession. From a Minsky

perspective, an explanation of this recession must include cyclical and structuraldimensions,whileapolicystrategyrequiresattentiontobothrecoveryandreform.

The recent attention to Minsky’s ideas, both outside and within the academy, isencouraging.YetwedoourselvesandhismemoryadisservicewhenMinsky’s insights are

reducedtoananalysisofasingleeventorevenoffinancialinstability.Standingsquarelyon

theshouldersofMinskymeansunderstandingthelatestbusinesscyclewithinthecontextofmoney‐managercapitalism,anditmeansseeking toguidethefurtherdevelopmentofthe

systeminamorehumanedirection.

NOTES

1.Homeownerswere alsoable to fuel aconsumptionboomby taking on evenmoredebt.

That is because rising home prices encouraged banks to increase customers’ credit‐cardlimitsandtoheavilypromotehome‐equityloans(ChuandAcohido2008;Story2008).

2.DymskiandPollinadd:‘Whenboomconditionsdoend,aggressivemanagerswillalreadyhavebeen promoted,while cautiousmanagerswill havebeendemoted, if not dismissed.

Moreover, during the slump, all aggressive managers will fail together, so no single

individual will be singled out for blame. This is in contrast to the boom, where themiscalculatingcautiouswillhavebeenisolated’(DymskiandPollin1992,45).

3.Ofcourse,BearStearnsitselfwastobeacasualtyofthecrisisinearly2008.4. Here are some figures that indicate themagnitude of U.S. mortgage securitization: in

early2007,about65percentofmortgageswerebeing turnedintobondsviasecuritization,

up from 40 percent in 1990; and, in the years 2004‐2006, nearly $100 billion per year inoptionARMsweresoldtoinvestors(Pittman2007;DerHovanesian2006).

5.Mortgagebrokers,whooperatewithoutmuchgovernment regulation,accountedfor80percent ofall U.S.mortgageoriginationsin 2006,double theirshareadecadeearlier(Der

Hovanesian2006).

6. According to theFederalHousing FinanceAgency,mortgagedelinquenciesamong themostcreditworthyhomeowners (primeborrowers) holding loansownedorguaranteedby

FannieMaeandFreddieMacrose 50 percent fromDecember2008 to January2009(from497,131to743,686)“asborrowerssaiddropsinincomeortoomuchdebtcausedthemtofall

behind”(Kopecki2009).

7.Theprimaryfocusof thisdiscussion isontheUnitedStates,notmerelybecause this iswheremostoftherecenteconomictroubleoriginated,butalsobecauseitisthemainfocus

ofMinsky’sanalyses.8.Anotherreasonforsuggestingthe2009stimuluswastootimidisthatthefirst‐yeartax‐

cutmultipliersestimatedbyChristineRomerandJaredBernsteinwereconsiderablybelow

1.0(RomerandBernstein2009,12).Thus,modifyingthepackageinthedirectionoftaxcuts(toensurepassage)seemedilladvisedfromamacroeconomicperspective.

9.ItisinterestingtoobservetheFederalReserve’suseofthediscountwindowasameansofinfluencingthebankingsystemduringthecurrentcrisis.MinskyrecommendedthattheFed

increaserelianceonthismechanism throughoutthebusinesscycle,buthethought itwas

especiallyimportant to usethischannel in a fragilefinancial environment (Minsky 1986c,322‐328).

10. Foranunconventional look at Bernanke, including the suggestion ofa surprising linkbetweenMinskyandPrincetonUniversityfinancial‐marketresearchconvenedbyBernanke,

seeLahart(2008).

11.Theuseofleveragebyhedgefundsandthewritingofnodocumentationhomeloansareamongthepracticesingreatestneedofregulatoryattention.

12.Thereluctanceofgloballeaderstocooperateforthepurposeofestablishingafoundationforgreaterstabilityandmorewidespreadglobaleconomicwellbeing canbeseeneven the

currenteconomicclimate;seeZalewskiandWhalen(2009,17‐18).

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