Minsky Explains Bank Management Motivation

Michael Stephens | March 2, 2012

Your Minsky quotation of the day:

The rise in bank share prices that follows a growth in profitability is particularly important in a world of professionally managed institutionalized banks.  The typical professional bank president is not a rich man when he starts his career.  As a bank president he is a hired hand trying to achieve a personal fortune.  But given the tax structure, it is difficult to accumulate a fortune by saving out of income; the most efficient route for a business executive is by way of stock options and the capital gains that accrue as the stock market price per share rises.  As holders of stock options, bank management is interested in the price, on the exchanges, of their bank’s shares.

The price of any stock is related to the earnings per share, the capitalization rate on earnings of the bank’s perceived risk class, and the expected rate of growth of such earnings.  If bank management can accelerate the growth rate of earnings by increasing leverage without a decrease in the perceived security and safety of the bank’s earnings, then the price of shares will rise because both earnings and the capitalization rate on earnings that reflects growth expectations rise.  In a capitalist society with institutionalized organizations and tax laws such as ours, fortune-seeking by the mangers of institutionalized enterprises leads to an emphasis upon growth, which in turn leads to efforts to increase leverage.  But increased leverage by banks and ordinary firms decreases the margins of safety and thus increases the potential for instability of the economy.

From Minsky’s “Stabilizing an Unstable Economy,” p. 266 (first published in 1986, though I’m told largely finished by 1982).


One Response to “Minsky Explains Bank Management Motivation”

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  1. Comment by Economic Maverick'March 2, 2012 at 5:22 pm   Reply

    Damn, his thinking was clear and elegant! I wish i could do that

    I wonder if Minsky writing this in 1982 was also thinking about Jensen’s famous 1976 paper on the “Principal – Agency” problem? I’m guessing by the early 80s, we were probably already seeing a significant move towards stock option based compensation of executives – influenced by Jensen’s paper, pushed by strategy consultants (especially Bain) – ostensibly to align executive interest with long term shareholder interest.

    It’s amazing how he saw the rise of so many things in the future, to the LBO crazes of the 80s and 2000s, to the dot-come bubble, to multiple housing/asset bubbles of the last 30 years

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