Hyman Minsky's theories about debt accumulation received revived attention in the media during the subprime mortgage crisis of the first decade of this century. The New Yorker has labelled it "the Minsky Moment".[11][12]Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.The "hedge borrower" can make debt payments (covering interest and principal) 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 roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi, see also Ponzi scheme) 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 the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.
These 3 types of borrowers manifest into a 3 phased system:Hedge Phase:This phase occurs right after a financial crisis and after recovery, during a point at which banks and borrowers are overtly cautious. This causes loans to be minimal ensuring that the borrower can afford to repay both the initial principal and the interest. Thus, the economy is most likely seeking equilibrium and virtually self-containing. This is the “not too hot not too cold” Goldilocks phase of debt accumulation.Speculative phase:After some progression in the Hedge phase, the Speculative period emerges as confidence in the banking system is slowly renewed. As banks continue this observation, they continue this risky process. Rather than issue loans to borrowers that can pay both principal and interest; loans are issued where the borrower can only afford to pay the interest. This begins the decline to instabilityPonzi Phase:As confidence continues to grow in the banking system and banks continue to believe that asset prices will continue to rise, the third stage in the cycle, the Ponzi stage, begins.In the final stage of the FIH, the borrower can neither afford to pay the principal nor the interest on the loans which are issued by banks leading to foreclosures and vast debt failures.If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.[6]
Minsky's periods of capitalism
Though Minsky's research in the 1980s depended on Keynesian analysis, he thought that changes in the structure of the US economy by then required new analysis, and for this he turned to Schumpeter.[14] Both Schumpeter (and Keynes), Minsky argued, believed that finance was the engine of investment in capitalist economies, so the evolution of financial systems, motivated by profit-seeking, could explain the shifting nature of capitalism across time. From this, Minsky split capitalism into four stages: Commercial, Financial, Managerial and Money Manager. Each is characterized by what is being financed and who is doing the financing.
Money Manager Capitalism
Minsky argues that due to tax laws and the way markets capitalized on income, the value of equity in indebted firms was higher than conservatively financed ones. [Leverage is very good]This led to a shift, as explained by Minsky, A market in the control of firms developed: the fund managers whose compensation was based on the total returns earned by the portfolio they managed were quick to accept the higher price for the assets in their portfolio that resulted from the refinancing that accompanied changes in the control of firms. In addition to selling the equities that led to the change in control, the manager of money were buyers of the liabilities (bonds) that came out of such a refinancing.The independence of operating corporations from the money and financial markets that characterized the managerial capitalism was thus a transitory stage. The emergence of return and capital-gains-oriented blocks of managed money resulted in financial markets once again being a major influence in determining the performance of the economy.However, unlike the earlier epoch of finance capitalism, the emphasis was not upon the capital development of the economy but rather the upon the quick turn of the speculator, upon trading profits.
