Research Topics

Minsky’s Forgotten Lessons Ten Years after Lehman

Ten years after the fall of Lehman Brothers and the collapse of the US financial system, most commentaries remain overly focused on the proximate causes of the last crisis and the regulations put in place to prevent a repetition. According to Director of Research Jan Kregel, there is a broader set of lessons, which can be unearthed in the work of Distinguished Scholar Hyman Minsky, that needs to play a more central role in these debates on the 10th anniversary of the crisis.
 
This insight begins with Minsky's account of how crisis is inherent to capitalist finance. Such an account directs us to shore up those government institutions that can serve as bulwarks against the inherent instability of the financial system—institutions that can prevent that instability from turning into a prolonged crisis in the real economy.
 

Edited by Rainer Kattel, Jan Kregel, and Mario Tonveronachi

Have past and more recent regulatory changes contributed to increased financial stability in the European Union (EU), or have they improved the efficiency of individual banks and national financial systems within the EU? Edited by Rainer Kattel, Tallinn University of Technology, Director of Research Jan Kregel, and Mario Tonveronachi, University of Siena, this volume offers a comparative overview of how financial regulations have evolved in various European countries since the introduction of the single European market in 1986. The collection includes a number of country studies (France, Germany, Italy, Spain, Estonia, Hungary, Slovenia) that analyze the domestic financial regulatory structure at the beginning of the period, how the EU directives have been introduced into domestic legislation, and their impact on the financial structure of the economy. Other contributions examine regulatory changes in the UK and Nordic countries, and in postcrisis America.

Published by: Routledge

No Solution for Financial Reform

Before the law has even been fully implemented, the inadequacies of the regulatory approach underlying the Dodd-Frank Act are becoming more and more apparent. Financial scandal by financial scandal, the realization is hardening that there is a pressing need to search for more robust regulatory alternatives.

The real challenge for financial reform is to develop a vision for a financial structure that would simplify the system and the activities of financial institutions so that they can be regulated and supervised effectively. Some paths to such simplification, however, are not worth treading. Against the backdrop of renewed present-day interest in the Depression-era “Chicago Plan,” featuring 100 percent reserve backing for deposits, Senior Scholar Jan Kregel turns to Hyman Minsky’s consideration of a similar “narrow banking” proposal in the mid-1990s. For reasons that eventually led Minsky himself to abandon the proposal, as well as reasons developed here by Kregel that have even more pressing relevance in today’s political climate, plans for a narrow banking system are found wanting.

Hyman Minsky had particular views about how the regulatory system and financial architecture should be reformulated, and one of the many lessons we can learn from his work is that there is an intimate connection between how we think about the prospect of financial market instability and how we approach financial regulation. Regulation cannot be effective if it is simply based on “piecemeal” measures produced in response to the current “moment,” Minsky wrote. It needs to reformulate the structure of the financial system itself.

This eBook traces the roots of the 2008 financial meltdown to the structural and regulatory changes leading from the 1933 Glass-Steagall Act to the 1999 Financial Services Modernization Act, and on through to the subprime-triggered crash. It evaluates the regulatory reactions to the global financial crisis—most notably, the 2010 Dodd-Frank Act—and, with the help of Minsky’s work, sketches a way forward in terms of stabilizing the financial system and providing for the capital development of the economy.
The book explains how money manager capitalism set the stage for the outbreak of the systemic crisis and debt deflation through which we are still living. And it explains that, despite calls for a return to Glass-Steagall, we cannot turn back the clock. Minsky’s blueprint for a more stable structure is smaller banks and the restoration of relationship banking. Modifying and extending his idea for creating a bank holding company would preserve some of the features of Glass-Steagall. 

This monograph is part of the Institute’s research program on Financial Instability and the Reregulation of Financial Institutions and Markets, funded by the Ford Foundation. Its purpose is to investigate the causes and development of the recent financial crisis from the point of view of the late financial economist and Levy Distinguished Scholar Hyman Minsky, and to propose “a thorough, integrated approach to our economic problems.”

The monograph draws on Minsky’s work on financial regulation to assess the efficacy of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in response to the 2008 subprime crisis and subsequent deep recession. Some two years after its adoption, the implementation of Dodd-Frank is still far from complete. And despite the fact that a principal objective of this legislation was to remove the threat of taxpayer bailouts for banks deemed “too big to fail,” the financial system is now more concentrated than ever and the largest banks even larger. As economic recovery seems somewhat more assured and most financial institutions have regrouped sufficiently to repay the governmental support they received, the specific rules and regulations required to make Dodd-Frank operational are facing increasing resistance from both the financial services industry and from within the US judicial system.

This suggests that the Dodd-Frank legislation may be too extensive, too complicated, and too concerned with eliminating past abuses to ever be fully implemented, much less met with compliance. Indeed, it has been called a veritable paradise for regulatory arbitrage. The result has been a call for a more fundamental review of the extant financial legislation, with some suggesting a return to a regulatory framework closer to Glass-Steagall’s separation of institutions by function—a cornerstone of Minsky’s extensive work on regulation in the 1990s. For Minsky, the goal of any systemic reform was to ensure that the basic objectives of the financial system—to support the capital development of the economy and to provide a safe and secure payments system—were met. Whether the Dodd-Frank Act can fulfill this aspect of its brief remains an open question.

On July 9, 2009, Senior Scholar James K. Galbraith testified before the House Financial Services Committee regarding the functions of the Federal Reserve under the Obama administration’s proposals for financial regulation reform—specifically, the extent to which the newly proposed role of systemic risk regulator might conflict with the Fed’s traditional role as the independent authority on monetary policy. He also addressed questions of whether the Fed should relinquish its role in consumer protection, and whether the shadow banking system should be restored.

 

Galbraith pointed out that the Board’s primary mission is macroeconomic: “Rigorous enforcement of safety and soundness regulation is never going to be the first priority of the agency in the run-up to a financial crisis.” Systemic risk regulation needs to be deeply integrated into ongoing examination and supervision—a function best taken on by an agency “with no record of regulatory capture or institutional identification with the interests of the regulated sector.” That agency, said Galbraith, is the FDIC. If systemic risk is to be subject to consolidated prudential regulation, why not place that responsibility in the hands of an agency for which it is the first priority? Further, if large banks and other financial holding companies pose systemic risks, why not require them to divest and otherwise reduce the concentration of power that presently exists in the financial sector? In Galbraith’s view it would, over time, “bring the scale of financial activity into line with the capacity of supervisory authorities to regulate it, and the result would be a somewhat safer system.”