Archive for April, 2012

National Fragmentation of Credit in the Eurozone

Michael Stephens | April 18, 2012

In a Bloomberg article that details how banks in the eurozone periphery have begun carrying increasing proportions of the debt issued by their own nations’ governments (while banks in the core have reduced their holdings of peripheral sovereign debt), Dimitri Papadimitriou comments on some of the consequences of this “national fragmentation of credit”:

“If there’s a private-sector restructuring of Portuguese sovereign debt, then Portugal’s banks will need a bailout like Greek banks did,” Dimitri Papadimitriou, president of the Levy Economics Institute at Bard College in Annandale-on-Hudson, New York, said in an interview.

In Spain, stronger banks such as Banco Santander SA (SAN), the country’s largest lender, can handle losses from their sovereign holdings, while weaker savings institutions stung by soured real estate loans will need help, Papadimitriou said. Italian banks probably are buying more of their country’s debt because they can sell it to retail customers who still have an appetite for the securities, he said.

Read the article here.


21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability

L. Randall Wray | April 16, 2012

The annual Minsky conference, co-sponsored by the Levy Institute and the Ford Foundation, was held this past week in NYC. The audio transcripts of all the presentations (including one by yours truly) are online here. (I will also add my powerpoint below so you can look at it while listening to the audio.)

My presentation quickly summarized results of a project I am directing that examines democratic governance and accountability of the Federal Reserve, focusing on its response to the global financial crisis. You can read our first report here.

I won’t go into that today. I just wanted to very quickly summarize two quite interesting statements made by others over the course of the conference.

First, Joe Stiglitz had a great analogy about derivatives. Recall that part of the reason for the creation and explosion of derivatives was to spread risk. For example, mortgage-backed securities were supposed to make the global financial system safer by spreading US real estate risks all over the world. He then compared that to, say, a deadly flu virus. Would you want to spread the virus all over the world, or quarantine it? Remember Warren Buffet’s statement that all these new financial products are “weapons of mass destruction”–like the 1914 flu virus. And, indeed, just as Stiglitz said, spreading those deadly weapons all over the world ensured that when problems hit, the whole world financial system was infected.

The other observation was by Frank Partnoy, and also addressed the innovations in the financial sector. continue reading…


Developing the ‘Financial Instability Hypothesis’: More on Hyman Minsky’s Approach

L. Randall Wray | April 15, 2012

(cross posted at EconoMonitor)

Since Paul Krugman kicked-off a heated discussion about Minsky’s views on banks, and because the annual “Minsky Conference” co-sponsored by the Ford Foundation and the Levy Economics Institute occurred this past week, I thought it would be useful to run a couple of posts laying out what Minsky was all about. This first piece will detail his early work on what led up to development of his famous “financial instability hypothesis.”

Minsky’s Early Contributions

In his publications in the 1950s through the mid 1960s, Minsky gradually developed his analysis of the cycles. First, he argued that institutions, and in particular financial institutions, matter. This was a reaction against the growing dominance of a particular version of Keynesian economics best represented in the ISLM model. Although Minsky had studied with Alvin Hansen at Harvard, he preferred the institutional detail of Henry Simons at Chicago. The overly simplistic approach to macroeconomics buried finance behind the LM curve; further, because the ISLM analysis only concerned the unique point of equilibrium, it could say nothing about the dynamics of a real world economy. For these reasons, Minsky was more interested in the multiplier-accelerator model that allowed for the possibility of explosive growth. In some of his earliest work, he added institutional ceilings and floors to produce a variety of possible outcomes, including steady growth, cycles, booms, and long depressions. He ultimately came back to these models in some of his last papers written at the Levy Institute. It is clear, however, that the results of these analyses played a role in his argument that the New Deal and Post War institutional arrangements constrained the inherent instability of modern capitalism, producing the semblance of stability.

At the same time, he examined financial innovation, arguing that normal profit seeking by financial institutions continually subverted attempts by the authorities to constrain money supply growth. This is one of the main reasons why he rejected the LM curve’s presumption of a fixed money supply. Indeed, central bank restraint would induce innovations to ensure that it could never follow a growth rate rule, such as that propagated for decades by Milton Friedman. These innovations would also stretch liquidity in ways that would make the system more vulnerable to disruption. If the central bank intervened as lender of last resort, it would validate the innovation, ensuring it would persist. Minsky’s first important paper in 1957 examined the creation of the fed funds market, showing how it allowed the banking system to economize on reserves in a way that would endogenize the money supply. The first serious test came in 1966 in the muni bond market and the second in 1970 with a run on commercial paper—but each of these was resolved through prompt central bank action. Thus, while the early post-war period was a good example of a “conditionally coherent” financial system, with little private debt and a huge inherited stock of federal debt (from WWII), profit-seeking innovations would gradually render the institutional constraints less binding. Financial crises would become more frequent and more severe, testing the ability of the authorities to prevent “it” from happening again. The apparent stability would promote instability. continue reading…


Galbraith: How $12 Minimum Wage Could Boost Economy

Michael Stephens | April 5, 2012


New Empirical Evidence of Long-lasting Effects of Mortgage Crisis

Greg Hannsgen | April 3, 2012

Debts left over on consumers’ balance sheets from the mortgage crisis have had particularly serious and long-lasting effects on the economic health of those localities where the crisis hit the hardest, according to what appears to be some  interesting and important evidence discussed in an article in today’s New York Times. Of course, the notion that such balance-sheet issues are crucial is a key part of the macroeconomics we work on here, and very much in the tradition of Godley, Minsky, and other heterodox economists.


Krugman vs Minsky: Who Should You Bank On When It Comes to Banking?

L. Randall Wray | April 2, 2012

Last week I explained why Minsky matters, outlining his main contributions. This was, in part, a response to a blog post by Paul Krugman that appeared to dismiss the importance of trying to find out “what Minsky really meant.” But, more importantly, it was a response to his defense of a simple model of debt deflation dynamics that left banks out of the picture. In Krugman’s view, banks are not very important since all they do is to intermediate between savers and investors, taking in deposits and packaging them into loans.

In my post last week I promised to go into more detail on Minsky’s approach to banking. And right on cue, Krugman expanded on his views in this post.

Now, I know that Krugman’s own specialty is not money and banking, so one would not expect him to have a deep understanding of all the technical details.  However, he is an important columnist and textbook writer, so if he is going to expound upon “what banks do,” he should at least have the basics more-or-less correct. But he doesn’t. Indeed, his views are outdated by at least a century, or more. Can one imagine a science writer at the NYTimes presenting Newtonian physics as state-of-the-art?

If there is any banking “mysticism,” it is what Krugman is presenting—not what Minsky’s followers are arguing. Yes, we need Minsky—whose views even from the 1950s are far more relevant to today’s real world banks than are Krugman’s.

I mean no disrespect here. Like the rest of Krugman’s followers, I think he’s one of the best columnists at the NYTimes–and he covers a great range of topics with flair and good insight. But he cannot be trusted when it comes to money—he just doesn’t get it. What he is presenting is a strange combination of early twentieth century theory plus a throwback to a particular nineteenth century view that was based on an even older “goldsmith” story. Let me explain. continue reading…