Editor Pick – Minsky’s Financial Instability Hypothesis presented by PIMCO
Paul McCulley from PIMCO presents us with a timely reminder of Hyman Minsky’s Financial Instability Hypothesis.
In Minsky’s own words (1974): “The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable.
The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.
In particular, over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make positions by selling out positions. This is likely to lead to a collapse of asset values.”
McCulley: Clearly, the explosion of exotic mortgages – sub-prime; interest only; pay-option, with negative amortization, et al – in recent years have been textbook examples of Minsky’s speculative and Ponzi units.
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