Time For Investors To Have Their Own Minsky Moment

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Written By Mahmoud Sarvari

Minsky finally had his moment following the downturn of 2007 as a new generation of economists turned to his writings once spurned by academics as a way of explaining boom and bust.

As a child of The Great Depression, he was driven by a desire to understand how the crisis was sparked.

Despite scoffing from other economists, Minsky slowly put together his theory of financial instability.

His starting point was that long stretches of prosperity end in a financial crisis.

Stability v risk

Minsky looked at three kinds of financing –

  • Hedge financing based on a company’s ability to cover debts from future cash flow based on good profits and a cap on borrowing
  • Speculative finance is when a company services interest payments on debts from cash flow but rolls over capital to repay the borrowed money
  • Ponzi financing is when companies do not have the cash to cover interest or capital payments and hope the value of the mortgage assets rise high enough during the term of the loan to pay off the debt

His theory was hedge economies were the most stable, while speculative and Ponzi economies were risky ventures that could collapse if financial difficulties arose.

Minsky explained that banks encourage borrowing in good times and investors and businesses are encouraged to take on more debt that they cannot service from cash flow.

Obvious explanations

His explanations seem so obvious as the world slowly recovers from a global financial crisis caused by casino economies where investment was based on gambling on growth rather than managing cash flow.

Investors came to understand that when debt reached a certain level, the financial system would start to break down and the value of businesses, properties and commodities would plummet.

Minsky was not clairvoyant and nor did he have the foresight to develop a theory that other economists were blind to.

Since his death, others have nabbed bits of his ideas and integrated them into mainstream economics.

Even Janet Yellen, chair of the US Federal Reserve, argues he is required reading and Bank of England governor Mark Carney cites Minsky as a source.