By now, you have heard the term ‘Minsky moment.’ It was coined by Pimco’s Paul McCulley to describe events in Russia that precipitated the LTCM crisis.  McCulley was referring to economist Hyman Minsky’s concept that long periods of stability cause people to take on ever more debt and ever more risk, leading to a gigantic meltdown.

James Galbraith does a good job of explaining this instability of stability in three videos below. Galbraith sees the latest episode of financial crisis as a Minsky moment predicated on ‘Ponzi’-style debt pyramiding that is the end game in the cycle of stability to instability, just as it was post-1929.

My view is that a lack of regulatory oversight allowed the system to veer away from macro-prudential finance (see my little playground analogy with Greenspan as headmaster here). This is not a case of Madoff-style fraud with everyone in finance cooking up schemes to defraud homeowners. Yes, these cases of predatory lending existed. However, I see the systemic risk as more pertinent.

Systemically-speaking, the Ponzi phase is one of risky behavior crowding out prudent behavior in a world free of regulatory controls. If risky behavior is temporarily rewarded with profit and this temporary period is long enough, then risky behavior wins and drives out good behavior.

In the last few years – even the last few decades, financial interests have used the lack of regulatory controls and their increased access to political power to profit using risky financial instruments. They have done so by creating a byzantine maze of Ponzi-style debt schemes (think CDOs levered on mortgage-backed securities or think credit default swaps). I consider this looting as it represents a transfer of income to them from everyone else. Galbraith calls this the Predator State.

How one deals with the intrinsic instability of the capitalist system in an environment of powerful special interests is the fundamental question we face in fixing finance. The natural tendency toward greater risk in a stable macro environment is toxic when mixed with lax regulatory oversight and crony capitalism. Bailing out the system without punishing the fraud while permitting risky actors and their investors to escape the full consequences of their behavior is a moral hazard. This invites more of the same in future.

As for the present day, Galbraith talks about government as the cushion between us and Depression. I see this as an accurate view. Whether this is the advisable way forward (i.e. should we take the pain now?), depends on your view on government’s role in the economy. I believe that witnessing yet more crony capitalism in this depressionary environment will almost certainly induce ‘big government revulsion’ and lead to a recessionary relapse. See my post “A few thoughts about the limitations of government.”

Running time about 45 minutes in three parts.

Enjoy.

(three videos embedded above. If they don’t appear, go to the original post here.)

This is a guest post by Edward Harrison. A version of this post originally appeared at Credit Writedowns.

Category: Credit, Cycles, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

11 Responses to “Galbraith: Financial stability creates instability”

  1. I fall into the small government camp because Keynesian economics doesn’t work. It didn’t work in the Great Depression, and it hasn’t worked in Japan. Governments do not allocate capital in the most effective manner, and they do not create wealth. They merely redistribute based on the rules of crony capitalism. This spending crowds out spending by entrepreneurs and corporations as they have less access to capital and hoard capital for fear of future taxes (or a changing of the rules by government). This prevents a true recovery.

    The only reason Fed and fiscal stimulus has worked in the previous post WWII recessions is because we were building our debt levels. The economy was growing due to the expansion of debt, not from savings and investment. Now that the debt deflation has begun, those tools will not have the same effect. In fact, these methods will be the obstacles to true growth just as they were in the 1930s and Japan.

    As much as people hate to think of it, we are better off taking our lumps now and getting on with life. We will start growing much quicker that way as the excesses are worked off.

  2. bsneath says:

    This is an excellent post.

    Mr. Harrison states: “….How one deals with the intrinsic instability of capitalist system in an environment of powerful special interests is the fundamental question we face in fixing finance…..I believe that witnessing yet more crony capitalism in this depressionary environment will almost certainly induce ‘big government revulsion’ and lead to an recessionary relapse.”

    These are the utmost concerns that most of us share.

    Do our leaders have the will and character necessary to stand up against the powerful special interests and fix the instabilities inherent in the financial system?

    Do they understand the depth of anger in the general population resulting from the on going improper relationships between corporations, banks and government officials?

    Are they aware of the growing numbers who are demanding that they cut government spending and balance federal budgets at a time when such actions could trigger a recessionary relapse?

    By succumbing to the siren call of Wall Street’s money, the Obama Administration might well be risking it all. The populist backlash could well exceed the value of all of those additional campaign adverts being funded by Goldman Sachs and friends.

  3. kevinearick says:

    The balance of power lies between labor and capital, and evolution favors labor; Without labor, capital becomes inert, so labor grants capital government, a fulcrum, to balance the platform. So long as capital does not intervene with natural new family formation, the labor side of the fulcrum will grow, and capital may employ government to grow and balance the platform.

    Because natural new family formation is subjected to direct evolutionary pressure, it creates all the new processes, and capital’s function is to distribute those processes and recycle the old ones. Capital must be efficient. Labor must be effective. Natural new family formation is the self-adjusting mechanism of economics.

    Fulcrum action:

    Government works for capital, always has, always will. Through government, capital offers subsets of labor, those closest to it, at the top of the middle class, short-term benefits in exchange for long-term, structural control over returns from the economy, from the top down, liquidating from the bottom up, and distilling labor into a subset that increasingly makes decisions based on the future.

    Capital’s momentum eventually leads it to short circuit the agreement by interfering with new family formation, to favor weaker contractual counter-parties. By that time the remainder of labor is already well on its way to completing the bridge to the next economy. The old economy self-liquidates, it inverted pyramid of capital collapses, and the next economy is launched.

    This process of population distillation, and reef development, which results in either symbiotic adaptation, or replacement, once the demographic acceleration curve hits the ceiling. Humanity has hit the ceiling. The population will continue to grow, but at a decelerating pace, liquefying the demographic, Ponzi economy. If a species cannot reach a stable, symbiotic, equilibrium orbit, evolution always has another species ready to go in the bullpen.

    When capital shorted the Constitution, through the US Supreme Court, with Family Law, and Congress did not respond, the US Government became illegitimate, leaving capital with nothing but the too-big-to-fail strategy, which has no exit plan, and has run its course.

    Can we fix it? Yes.

    The question is how large will the population be on the other side of the democratic education system bridge? And that is up to capital. Distilled labor is already completing the next bridge in this series, with a new breeding program.

    Labor requires a minimum 51% return on the economy, to meet evolutionary requirements, and to maximize both capital scale and diversity. Above 51% reduces capital, below liquidates the economy. Labor works at the pleasure of planet to build up capital, not the other way around. The planet is in no danger; it is a buffer of symbiotic processes well beyond human control.

    A constitution protects capital from self-liquidation. Evolution protects labor that serves its purpose.

    We have reached the tipping point of full disclosure.

    What is the difference between a point, a circle, and a helix? time / relativity.

    That clock in your head is a construct, creating the illusion of individuality in time; it serves the purpose of the universe.

    Once you see the circuit in its entirety, you can operate in any department, because you are acutely aware of the amperage separating them, having survived electrocution. I do not recommend this route.

    There is one and only one door to the future, the same door, and keys vary depending on the entity at the door.

    Oh yea, the recession is over. We are in recovery mode. Just ask Deval Patrick, who was told by David Tuerek, and confirmed by Barney Frank. They were measuring at the drain of deficit spending, and on the back of increased lottery revenue. Go figure.

  4. kevinearick says:

    The balance of power lies between labor and capital, and evolution favors labor; Without labor, capital becomes inert, so labor grants capital government, a fulcrum, to balance the platform. So long as capital does not intervene with natural new family formation, the labor side of the fulcrum will grow, and capital may employ government to grow and balance the platform.

    Because natural new family formation is subjected to direct evolutionary pressure, it creates all the new processes, and capital’s function is to distribute those processes and recycle the old ones. Capital must be efficient. Labor must be effective. Natural new family formation is the self-adjusting mechanism of economics.

    Fulcrum action:

    Government works for capital, always has, always will. Through government, capital offers subsets of labor, those closest to it, at the top of the middle class, short-term benefits in exchange for long-term, structural control over returns from the economy, from the top down, liquidating from the bottom up, and distilling labor into a subset that increasingly makes decisions based on the future.

    Capital’s momentum eventually leads it to short circuit the agreement by interfering with new family formation, to favor weaker contractual counter-parties. By that time the remainder of labor is already well on its way to completing the bridge to the next economy. The old economy self-liquidates, it inverted pyramid of capital collapses, and the next economy is launched.

    This process of population distillation, and reef development, which results in either symbiotic adaptation, or replacement, once the demographic acceleration curve hits the ceiling. Humanity has hit the ceiling. The population will continue to grow, but at a decelerating pace, liquefying the demographic, Ponzi economy. If a species cannot reach a stable, symbiotic, equilibrium orbit, evolution always has another species ready to go in the bullpen.

    When capital shorted the Constitution, through the US Supreme Court, with Family Law, and Congress did not respond, the US Government became illegitimate, leaving capital with nothing but the too-big-to-fail strategy, which has no exit plan, and has run its course.

    Can we fix it? Yes.

    The question is how large will the population be on the other side of the democratic education system bridge? And that is up to capital. Distilled labor is already completing the next bridge in this series, with a new breeding program.

    Labor requires a minimum 51% return on the economy, to meet evolutionary requirements, and to maximize both capital scale and diversity. Above 51% reduces capital, below liquidates the economy. Labor works at the pleasure of planet to build up capital, not the other way around. The planet is in no danger; it is a buffer of symbiotic processes well beyond human control.

    A constitution protects capital from self-liquidation. Evolution protects labor that serves its purpose.

    We have reached the tipping point of full disclosure.

    What is the difference between a point, a circle, and a helix? time / relativity.

    That clock in your head is a construct, creating the illusion of individuality in time; it serves the purpose of the universe.

    Once you see the circuit in its entirety, you can operate in any department, because you are acutely aware of the amperage separating them, having survived electrocution. I do not recommend this route.

    There is one and only one door to the future, the same door, and keys vary depending on the entity at the door.

    Oh yea, the recession is over. We are in recovery mode. Just ask Deval Patrick, who was told by David Tuerek, and confirmed by Barney Frank. They were measuring at the drain of deficit spending, and on the back of increased lottery revenue. Go figure.

  5. call me ahab says:

    “Bailing out the system without punishing the fraud while permitting risky actors and their investors to escape the full consequences of their behavior is a moral hazard. This invites more of the same in future.”

    exactly Ed- good post-

    I wonder if anyone will ever be held accountable- as if no crime had been committed

  6. Mannwich says:

    @ahab: I’m beginning to think the reason we haven’t seen anyone held accountable is that there are too many to hold accountable, as in most of the financial services sector, which would then reveal it to the world once and for all just what an utter sham (maybe biggest sham in world history) 75% of the system really is….

    So the charade goes on.

  7. bsneath says:

    Mannwich Says: “I’m beginning to think the reason we haven’t seen anyone held accountable is that there are too many to hold accountable…”

    No doubt, but not everyone needs to be caught. There is much to be said for making an example out of a few to set straight the rest.

    A good start would be with the investigation of Mr. Stephen Friedman’s purchase of Goldman Sach’s stock based on his insider information of the AIG deal while serving as the Chairman of the New York Federal Reserve. It is said he made $5 million on this transaction. It is a gross violation of the public trust and should be rigorously pursued. JMO

  8. Theodore D. says:

    Great stuff – IBGUBG

    It’ll all collapse but I’ll be gone, U’ll be Gone(IBGUBG)

  9. algernon says:

    “the intrinsic instability of capitalist system in an environment of powerful special interests”

    You can hardly accuse the US of being a capitalist system when the gov’t suppresses market-produced money in order to manipulate its fiat money & bails out companies that would be bankrupt in a true capitalist society. Powerful special interest can’t steal taxpayers’ money in a capitalist country.

    Credit booms can certainly happen in an actual free market society, but (1) there are natural counter-vailing forces in a true free market, & (2) our present one was caused by gov’t central banks.

  10. Mannwich says:

    @bsneath: But beware of peeling too many layers of that onion away. What is discovered may not be too pleasant, in fact I’m sure it’s not.

  11. torrie-amos says:

    let’s all be realists, what has happened will continue, for the last 20 years huge white collar corporate crime goes unpunished by jail terms for the most part, the bad actors get there monies, and when the company is caught they pay a huge fine, UBS today 550 million, no jail terms, no being away from loved ones, no claw backs

    so, the moral of the story of this is you can steal all the money you want as long as you don’t use a gun and hurt someone physically, the more layers between you and the crime the less likely you will ever pay

    and the beat goes on, imho, this will not change, there is zero incentive too, it has just basically been condoned by the government as good to go