From an institutional sales desk that must remain anonymous

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There something very unnerving about this Minsky conference and I may be getting closer to putting my finger on what that is. There are myriad differences between adherents of the Austrian School of economics (“Austrians” from now on) and Minskians, who view themselves as a kind of elite guard in the Keynesian army. I won’t go into them all here, mostly because I am first and foremost a market enthusiast and have only an amateurish understanding of the two schools. I’ve read some Von Mises, I’ve read some Menger, I’ve read some Hayek, I’ve read some Keynes and I’ve read some Minsky. I have friends who hail from both camps and have been party to vigorous debates on the relative merits of the two schools. That’s the extent of my knowledge – well, that and a B.A. in economics – and I don’t want to hold myself out as an expert.

That disclaimer aside, I have an observation to make about the Minskians: you have to be very smart to be one. I mean, you have to be very smart…preferably brilliant. Let me give you an example of what I mean. Here is how Gary Gorton (professor of finance at Yale and a research associate at the NBER) began his presentation this afternoon (you can access all of these presentations in audio form here: http://www.levyinstitute.org/news/?event=32):

“I’m going to talk about ‘talking.’ I’m going to talk about talking about the financial crisis. As a by-product of that I will talk about the financial crisis. I want to talk about how we talk about the financial crisis and why we talk a certain way about the financial crisis.”

That, I think, sums up well the level of thinking (and talking!) that’s being done at this conference. The Gorton speech was phenomenal. He drew on a working knowledge of two hundred years of American economic history in making his argument, which goes (I think) something like this:

1. All financial crises begin with an impulse by lenders or depositors to secure their cash, and in that regard this crisis was not out of the ordinary. The “shadow banking system” was outside of the regulatory landscape and was therefore unprotected and vulnerable to a “run.” Contrary to popular opinion, CDOs and derivatives weren’t the root of the problem – a run on the repo market was, as lenders in that market moved to secure their cash.

2. The run on the ~$10trillion repo market resulted from a shortage of good collateral (an age-old economic problem, according to Gorton, although I confess I’ve never seen it emphasized by other economists).

3. Academic economists were caught totally flat-footed by the crisis and only pretended that they understood it after the fact. The reason they were caught flat-footed is because the existence of the Fed had led them to believe that such a crisis was no longer possible. In fact, if you look at modern crises – the Japanese real estate/stock market bust for example or the S&L crisis in the U.S. – you’ll see that economic and financial market participants don’t act the way they would normally act if there wasn’t a central bank. Nobody panics because it’s ingrained in them that the central bank will act to snuff out any “run.”

4. As a result of this ingrained belief in the agency of the Fed (or central banks in general), economists’ collective focus has shifted away from the underlying “shortage of good collateral” problem and toward the problems caused by the government’s response to the underlying problem. That is, the focus shifts to “moral hazard” and “too big to fail.”

5. The real problem is that government/central bank intervention is unreliable. Therefore, economists, who are the crossing guards for the economy so to speak, don’t know whether to anticipate the fallout from the financial system’s underlying problems (e.g. a “shortage of good collateral” leading to a run on repos) or the fallout from the government’s interventions.

I’m doing his speech a disservice with this recap, because his insights really come through in the details and the examples, but hopefully you get a flavor for the kinds of discussions taking place at this conference.

Not all of the speeches are brilliant, of course, but enough of them are to make it a worthwhile experience. You can do worse than spend an afternoon at the website which I’ve linked to above to listen to some of them (I’d recommend Randall Wray and Eric Tymoigne in session 1, Steve Randy Waldman in Session 2, Andrew Sheng, Rob Parenteau and Marshall Auerback in session 5, and Gary Gorton).

The problem which nags me, however, and I’ve alluded to this above, is that the level of brilliance needed to untangle the inner workings of our financial system is absurd. It just shouldn’t be this complicated, this reflexive, or this psychological. Austrians happen to understand that, and they propose an economic system which really isn’t a system at all. You have commodity-based money, well-defined property rights, no lender of last resort for the banking system, and economic actors figure out the rest themselves. I promise I will delve more into this debate in my weekend note.

Category: Bailouts, Philosophy, Think Tank

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.

8 Responses to “Minsky Conference Update”

  1. tebee says:

    The problem is that if the financial system was so simple that most people could understand it there would be much fewer opportunities for everyone to make money from it.

    Whether this is is a good thing or bad is open to debate, but as the people who are running the system are among those who make the money nothing is liable to change in the foreseeable future .

    Most intelligent investors make their money by gambling that their understanding of what is happening is better than the rest of us. If the system was less opaque their would be fewer occasions when one could do this.

    But the main obstacle is that there is now a whole eco-system of people that have inserted themselves in to the food chain between the public and the financial system who rely on the former not being able to understand the later to make their living – everyone from fund managers to financial bloggers(!). There is no way they are going to commit commercial suicide by building a logical system that anyone can understand.

  2. wsm3 says:

    Looking forward to your further discussion this weekend.

  3. A Farmer says:

    Really, aren’t the Austrians the Evangelican Fundamentalists of the Economic world, while the Minskians are the quantum physicists? I can understand the “they get what’s coming to them” view of austerity from the Austrians, and as a saver, I can relate. But to apply such a “system to a world with 7 billion people doesn’t make much sense. Of course, if I had invested a couple hundred thousand dollars in gold, I’d love to see the world go to a gold standard, where all global capital is now only convertible into a few hundred million ounces of something I’ve got a pretty good stack of.

    As to how an economy encompassing those 7 billion people of different educations, cultures, nations, etc. is going to interact and function, I trust the smart guys more.

  4. AHodge says:

    gorton usefully points to repo as one cause–but its last minute Minsky Moment trigger cause
    the end of the usual minsky cycle of credit debt and collateral. that said he thin soup.

    the big new things of this one (briefest as i have said over and over here) were

    1 the new complex product. And the really bad accounting of it, a fake asset bubble-but real debt.
    (not just cyclically priced assets and nervous lenders as mostly before and assumed by minsky)

    2 fake “insurance” of the assets of all kinds, fannie freddie CDS reps and warranties repo guarantees

    3 downsides of the new securitization, including magnitudes “better” fraud and investors running away at minsky moments

    ” shortage of good collateral” is a weasel term, and does not account for point 1. what if banks wake up to the collateral being a “fake” asset, or guaranteed by fake insurance
    I ask you, is a fannie freddie guaranteed piece of mortgage crap a good asset in mid 2008 before we the people guaranteed FF on Sept5? is any “asset-backed” priced at hold to maturity “good collateral?”

    gorton manages to ignore (from wha ive seen) that
    the original sale, non govt guaranteed, securitization shut down by mid 2008,
    and markets in Sept 2008 also ran away from
    all commercial paper
    and money markets
    until guaranteed in sept oct

    your/his point 5 is unsupportable babble of the right wing “Austrian” lets blame the government variety
    not to mention claiming it also as the “real problem root problem”

  5. AHodge says:

    many austrian school would probably be appalled at some of the Ayn rand type “governmentless” thinking spouted in their name. including schumpater a genius austrian and a deep believer in capitalism, and renewing through its flaws.
    a Schump… quote that will appall that crowd claiming Austrian repectability.

    “Bureaucracy is not an obstacle to democracy but an inevitable complement to it”

  6. Mike S says:

    AHodge,

    Come on. Every Austrian I’ve ever met is a raving anti-government lunatic. The theory is not what Shump thinks, it is what passes for thought over at Mises.org.

    Many, if not a vast majority, of these people truly believe the world would be a better place with zero government.

    However, nice analysis. I’d agree with many of your critiques. That said, this analysis and the other analysis this person did as a follow up are excellent.

    This crisis caused a massive failure of the financial system. I find it hard to look at the system and not notice the huge, multiple frauds. But in many ways, the products were legit as well.

    Point 1 along with your critique of point 1 is a great example of the different ways to view this crisis. Yes, the products were fraudulent. But did the repo market know this? No. The repo market did not know this until the end. The fact that the repo market was unregulated made the fraud in a different market nearly catastrophic. Apply the Minsky hypothesis (competition forces leverage into products that make money + no planning for business cycles) to deliberate fraud and you get what we got. Either the fraud or the cycle would have been bad – but both causes huge, huge problems.

    Dude – I am with you. I really am. I just don’t want to close my eyes to the fact the repo market is a ticking time bomb even for legit products.

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