Just after the election, economist L. Randall Wray posted an article at the Levy Institute's blog, "Minskian Explanation of the Causes of the Current Crisis". I want to go over it, because I think it provides an invaluable perspective on the problems we confront, and is a natural extension of the concise overview offered by Wray in my Wednesday video posting, "Crash course on Hyman Minsky by L. Randall Wray". But this diary also ties into Mike's previous post, The Mystical Center, since a law & order crackdown on all the financial gambling, scheming and fraud goes hand-in-hand with a commitment to rebuild America as an agenda that appeals strongly to both the left and the center.
Wray begins by noting that attention has recently begun to shift to the role of fraud in the financial crisis, then points out that warnings to this effect had actually predated the crash itself, and furthermore that fraud had played a role in a whole series of episodes, going back at least to the Savings & Loans debacle of the mid-80s.
Seemingly, the crises have become more frequent and increasingly severe until almost the whole world was infected. It is obvious that there must be some link among these crises and that while fraud played a role in most or even all of them, it is not sufficient to lay blame on "bad apples", bad policy, insufficient foresight, and outright stupidity. We must find a more comprehensive explanation.
Which is to say, bad apples, bad policy, insufficient foresight and outright stupidity did not suddenly appear out of nowhere overnight. They have been with us always to varying degrees. What changed to make them so much more pernicious and synergistic with one another? That is what Minsky's persceptive helps explain:
Much of the world emerged from the Great Depression and World War II with a combination of institutions, regulations, financial practices, and memories that together encouraged relatively rapid economic growth, high employment, growing incomes, and growing confidence in our future. Private debt was low (mostly wiped out in the bankruptcies of the 1930s), government debt was high (war finance), and the financial system had been "simplified" (in Minsky's terminology). Big Corporations mostly used retained profits to finance expenditures; Big Unions kept wages growing so that workers could spend out of income rather than relying on debt; Big Government had filled portfolios of banks and savers with safe government bonds. Finance was kept small, constrained, and relatively irrelevant. Besides, memories of the Great Depression discouraged lending as well as borrowing. Strict regulation--especially in the US--kept risky financial practices segregated outside commercial banking.
Life was good in the golden post-war age. Heck, conservatives are forever celebrating how wonderful life was in the world that Keynes built. But, then...
If you want to understand the financial crisis, there are a number of different levels you can approach it on. But if you want to understand why capitalist financial systems repeatedly tend to crisis, you basically have two choices: Karl Marx and Hyman Minsky. Marx's explanation is the falling rate of profit as technologies mature and competition intensifies. Minsky's explanation is less well-known, but it deserves wider recognition. There's surprisingly little online I've been able to find that can serve as an introduction to his basic insight, but it really only takes one good presentation, and fortunately I've found one-a presentation paper by Paul McCulley, "The Shadow Banking System and Hyman Minsky's Economic Journey". As you can tell from the title, the paper actually does more than introduce Minsky's explanation, but the part of it that does introduce Minsky's insight is relatively self-contained, and the heart of it quotes directly from Minsky's own words. The shadow banking system did not exist as we know it when Minsky developed his ideas, which are far more general in how they describe how financial markets change over time.
First, McCulley does a very brief, capsule setup of Minsky's work by way of Keynes. He doesn't get into any of the details of Keynesian economics, but he nails the essence at one level--the difference between the micro and the macro, which then leads to a succinct statement of what Minsky did, followed by Minsky's own words, taking us to the very heart of his insight--the different sorts of of financing units, whose balance shifts over time, moving the economy from stability to instability. Let's take this one piece at a time. First the introductory nod to Keynes, and the nature of macro- vs. micro-economics:
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