Monday 2010-11-08

Financial Crises edited by Michael Bordo

A collection of economic disaster essays, the highlight of which is Hyman Minsky's.

To put my argument bluntly, the incipient financial crises of 1966, 1969-1970, and 1974-1975 were neither accidents nor the result of policy errors, but the result of the normal functioning of our particular economy...
As a result of normal market behavior the extraordinaryily robust financial structure inherited from World War II, in which a financial crisis was a vritual impossibility, was transformed into the fragile structure we now have, in which the periodic triggering of a financial crisis is well nigh certain.
-- Hyman Minsky, A Theory of Systemic Fragility
If a unit's cash flow commitments on debts are such that over each significant period the cash receipts are expected to exceed the cash payments by a significant margin, the unit is said to be engaged in hedge financing...
A speculative financing unit has cash flow payments over some periods -- typically near term -- that exceed the cash flows expected over this period. This situation usually arises because the principal amount of some debt is due...
A Ponzi financing unit is a speculative financing unit for which the interest portion of its cash payment commitments exceeds its net income cash receipts. A Ponzi unit has to increase its debt in order to meet commitments on outstanding instruments...
Commercial banks and depositary institutions, such as savings banks of various kinds, typically engage in speculative finance: The term to maturity of their debts is shorter than that of their assets (deposits + CDs < mortgages, commercial loans)...
Furthermore, a rise in interest rates can transform a speculative unit into a Ponzi financing unit, in that upon refinancing the cost of carrying position can exceed the income from the assets in position.
-- Hyman Minsky, A Theory of Systemic Fragility
Each collection of assets -- financial or capital -- is characterized by two explicit and one implicit cash flow. One explicit cash flow is the income -- for capital assets the quasi-rents -- it yields. The other explicit cash flow is the carrying costs. The implicit cash flow is the liquidity yield, which is the value of the insurance some assets provide because they can easily be turned into cash in order to fulfill payment obligations.
-- Hyman Minsky, A Theory of Systemic Fragility
Once a fragile financial structure exists, Federal Reserve policy should try to induce behavior that tends to diminish the weight of speculative finance in the economy. This may very well require some control over the liability structures and asset/equity ratios of giant corporations and banks.
-- Hyman Minsky, A Theory of Systemic Fragility