Research Topics

Financial Fragility and the Survival of the Single Currency

Given the continuing divergence between progress in the monetary field and political integration in the euro area, the German interest in imposing austerity may be seen as representing an attempt to achieve, de facto, accelerated progress toward political union; progress that has long been regarded by Germany as a precondition for the success of monetary unification in the form of the common currency. Yet no matter how necessary these austerity policies may appear in the context of the slow and incomplete political integration in Europe, they are ultimately unsustainable. In the absence of further progress in political unification, writes Senior Scholar Jan Kregel, the survival and stability of the euro paradoxically require either sustained economic stagnation or the maintenance of what Hyman Minsky would have recognized as a Ponzi scheme. Neither of these alternatives is economically or politically sustainable. 

The Indian Case

Financialization creates space for the financial sector in economies, and in doing so helps to raise the share of financial assets in the portfolios held by market participants. Largely driven by deregulation, the process works to make financial assets relatively attractive as compared to other assets, by offering both better returns and potential capital gains. Both the trend toward a more financialized economy and the expected returns on financial investments have provided incentives to corporate managers to invest larger sums in financial assets, resulting in growth of the share of financial assets relative to other assets held in portfolios. Assets held in the financial sector, however, failed to generate asset growth for the corporates. The need to obtain resources by borrowing in order to meet current liabilities reflects a pattern of Ponzi finance on their part. This paper traces the above pattern in corporate holdings of assets and its implications, with emphasis on the Indian economy.

Writing Down Debt, Returning to Democratic Governance, and Setting Up Alternative Financial Systems—Now

The five-year-long crisis of Western finance capitalism is pushing advanced liberal societies to a breaking point. If governments continue to be proxies of finance capital and aspiring political leaders cheerleaders for their financial backers, a catastrophic economic scenario is not really as far-fetched as some might like to think. Governments, industries, and households are under debt bondage, with the result that revenues from every sector of the economy are being diverted toward interest payments and late fees for various loans taken out on largely exploitative, even fraudulent terms. Now, after years of building up a Ponzi financial regime, Western capitalism faces its ultimate test. Will it collapse, giving rise to long-term economic instability and authoritarian political regimes? Or will it find the strength and the wisdom to make a comeback?

Research Scholar Greg Hannsgen and President Dimitri B. Papadimitriou disprove claims made by Social Security skeptics that the program is nothing more than a “Ponzi scheme.”

A Nonmainstream Perspective

The global financial crisis has now spread across multiple countries and sectors, affecting both financial and real spheres in the advanced as well as the developing economies. This has been caused by policies based on “rational expectation” models that advocate deregulated finance, with facilities for easy credit and derivatives, along with globalized exposures for financial institutions. The financial crisis has combined with long-term structural changes in the real economy that trend toward underconsumption, generating contractionary effects therein and contributing to further instabilities in the financial sector. The responses so far from US monetary authorities have not been effective, especially in dealing with issues of unemployment and low real growth in the United States, or in other countries. Nor have these been of much use in the context of the lost monetary and fiscal autonomy in both developing countries and the eurozone, especially with the debt-related distress in the latter. Solutions to the current maladies in the global economy include strict control of financial speculation and the institution of an “employer of last resort” policy, both at the initiative of the state.

Financial Fragility Indexes

With the Great Recession and the regulatory reform that followed, the search for reliable means to capture systemic risk and to detect macrofinancial problems has become a central concern. In the United States, this concern has been institutionalized through the Financial Stability Oversight Council, which has been put in charge of detecting threats to the financial stability of the nation. Based on Hyman Minsky’s financial instability hypothesis, the paper develops macroeconomic indexes for three major economic sectors. The index provides a means to detect the speed with which financial fragility accrues, and its duration; and serves as a complement to the microprudential policies of regulators and supervisors. The paper notably shows, notably, that periods of economic stability during which default rates are low, profitability is high, and net worth is accumulating are fertile grounds for the growth of financial fragility.

A Keynes-Minsky Episode?

The enormity and pervasiveness of the global economic crisis that began in 2008 makes it relevant to analyze the circumstances that can explain this catastrophe. This will also provide clues to the appropriate remedial measures needed to prevent future occurrences of similar developments.

The paper begins with some theoretical concerns relating to factors that could trigger a similar crisis. The first of these concerns relates to the deregulated financial institutions and the growing uncertainty that can be witnessed in these liberalized financial markets. The secondrelates to financial engineering with innovations in these markets, simultaneously providing cushions against risks while generating flows of liquidity that remain beyond the conventional sources of bank credit.

Interpreting the role of uncertainty, one can observe the connections between investment and finance, both of which are subject to changes in the state of expectations. The initial formulation can be traced back to John Maynard Keynes’s General Theory (1936), where liquidity preference is linked to asset prices and new investments. The Keynesian analysis of the impact of uncertainty related expectations was reformulated in 1986 by Hyman P. Minsky, who introduced the possibility of sourcing external finance through debt, which further adds to the impact of uncertainty. Minsky’s characterization of deregulated financial markets considers the newfangled sources of nonbank credit, especially with the involvement of banks in the securities market under the universal banking model.

As for the institutional arrangements that provide for profits on transactions, financial assets bought and sold in the primary market as initial public offerings of stocks are usually transacted later, in the secondary market, where these are no longer backed by physical assets.In the upswing, finance creates a myriad of financial claims and liabilities, and thus becomes increasingly remote from the real economy, while innovations to hedge and insulate assets continue to proliferate in the financial market, especially in the presence of uncertainty.

The paper dwells on an account of the pattern of the financial crisis and its spread in the United States. This is appended by a stylized account of the turn of events in terms of a theoretical model that highlights the role of uncertainty in the process.

An Evolutionary Approach to the Measure of Financial Fragility

Different frameworks of analysis lead to different conceptions of financial instability and financial fragility. On one side, the static approach conceptualizes financial instability as an unfortunate byproduct of capitalism that results from unpredictable random forces that no one can do anything about except prepare for through adequate loss reserves, capital, and liquidation buffers. On the other side, the evolutionary approach conceptualizes financial instability as something that the current economic system invariably brings upon itself through internal market and nonmarket forces, and that requires change in financial practices rather than merely good financial buffers. This paper compares the two approaches in order to lay the foundation for the empirical analysis developed within the evolutionary approach. The paper shows that, with the use of macroeconomic data, it is possible to detect financial fragility, especially Ponzi finance. The methodology is applied to residential housing in the US household sector and is able to capture some of the trends that are known to be sources of economic difficulties. Notably, the paper finds that Ponzi finance was going on in the housing sector from at least 2004 to 2007, which concurs with other works based on more detailed data.

The Methodological Puzzles of the Financial Instability Analysis

The recent revival of Hyman P. Minsky’s ideas among policymakers, economists, bankers, financial institutions, and the mass media, synchronized with the increasing gravity of the subprime financial crisis, demands a reappraisal of the meaning and scope of the “financial instability hypothesis” (FIH). We argue that we need a broader approach than that conventionally pursued, in order to understand not only financial crises but also the periods of financial calm between them and the transition from stability to instability. In this paper we aim to contribute to this challenging task by restating the strictly financial part of the FIH on the basis of a generalization of Minsky’s taxonomy of economic units. In light of this restatement, we discuss a few methodological issues that have to be clarified in order to develop the FIH in the most promising direction.

The Core of the Financial Instability Hypothesis in Light of the Subprime Crisis

This paper aims to help bridge the gap between theory and fact regarding the so-called “Minsky moments” by revisiting the “financial instability hypothesis” (FIH). We limit the analysis to the core of FIH—that is, to its strictly financial part. Our contribution builds on a reexamination of Minsky’s contributions in light of the subprime financial crisis. We start from a constructive criticism of the well-known Minskyan taxonomy o f financial units (hedge, speculative, and Ponzi) and suggest a different approach that allows a continuous measure of the unit’s financial conditions. We use this alternative approach to account for the cyclical fluctuations of financial conditions that endogenously generate instability and fragility. We may thus suggest a precise definition of the “Minsky moment” as the starting point of a Minskyan process—the phase of a financial cycle when many financial units suffer from both liquidity and solvency problems. Although the outlined approach is very simple and has to be further developed in many directions, we may draw from it a few policy insights on ways of stabilizing the financial cycle.