Economic action cannot, at least in capitalist society, be explained without taking account of money, and practically all economic propositions are relative to the modus operandi of a given monetary system. In this sense any theory of, say, wages or unemployment or foreign trade or monopoly must be a “monetary” theory, even if the phenomena under study can be defined in non-monetary terms. (Schumpeter 1939, 548)
It was not only in studying money that Minsky felt the need to reject the methodological assumptions of the economics discipline:
Much of present day price theory tends to identify price theory with marginal analysis. Marginal analysis is far from being a primitive concept; it is derived in the analysis of perfect competition. Marginal analysis is derived from profit maximization … the carrying over of profit maximization behavior to non-competitive markets has been the typical approach as far as price theory is concerned. Economists can be accused of being parrots who say that marginal x equals marginal y, and the position so determined is where the firm will operate.
Observed behavior of firms, any casual observation of the behavior of certain non-competitive firms during an inflationary period, can be interpreted to indicate that firms either lack the knowledge or the desire to behave as the marginal analysis indicates a firm should behave. The use of unmodified profit maximization as the sole basis for the analysis of firm behavior is a carry-over by the economist from the analysis of competitive markets. ([1954] 2000, 90f.)
Minsky did not hesitate to object to these two weaknesses of economic theory – leaving no room for money, and adherence to marginalism against the evidence: “The usual economic theory ignores financing problems and assumes a unique behavior principle for all firms (profit maximization, leaving only the trivial problem of the choice of the product to be produced to the firm” ([1954] 2000, 89). By relegating finance to the margins, by supposing that money is to be distinguished from what is “real,” by assuming a single mode of economic action, economists had assumed away the possibility for crisis. Without an understanding of finance, what could they say about the crash of 1929, or the closure of the banking system in 1933?
* * *
The crisis of 2008
In writing about financial crisis, a perennial topic and the one that oriented Minsky’s career, two points in time inevitably loom large: the next crisis and the last. Knowing that they come about, if not cyclically, at least repeatedly, it is hard to resist the temptation to imagine what will be the next crisis. Minsky’s work, as we shall see in some detail, helps us see how financial traumas grow from the quiescent periods that precede them; but having recognized this fact, one can quickly spot the seeds of crisis all around. This is not the same, however, as being able to offer a precise prediction. For these reasons I have tried, in what follows, to avoid predicting the next crisis; we shall have to wait and see.
The last crisis stands out in memory; indeed, a decade on, the debates and headlines that occupy the world’s attention today can still be traced along quite short paths back to the events of 2008. The subprime crisis, or the global financial crisis of 2008, was a major disruption: from a tipping point in the market for US real estate, it exposed the fragile arrangements in a global market-based credit system, bringing about the failures of major financial institutions, sparking a crisis in sovereign debt, and requiring coordinated intervention by central banks around the world. The consequences for employment, public finances, investment, not to mention politics and even, arguably, the course of history, have been and continue to be great. At the same time there is a risk of driving in the rear-view mirror, of preparing for the last war. Financial crises have a strong family resemblance, and at the same time each is unique; Minsky’s work, I argue, is more about the family resemblance than about any particular crisis, 2008 included.
I have aimed, therefore, to keep 2008 as an important example, but not the focus, for most of the book. Chapter 7 takes up the subprime crisis as a context for understanding the resurgent interest in Minsky’s work. Examples from the FCIC of the US Congress are included throughout the book as illustrations, in many cases quite precise ones, of Minsky’s insights. This section anticipates the discussion to follow with a short look at the events of the 2008 crisis. (I have tried to make this narrative both complete and efficient; as a consequence I fear it is slightly technical for an introductory section. To the interested reader for whom some of the financial vocabulary may be daunting, I suggest that you feel free to skip or skim this section. Its value might lie mostly in that it summarizes the events of the 2008 crisis from a viewpoint theoretically consistent with the other chapters of this book, and so I also suggest that you come back to it at the end.)
One of the signal developments in the world of finance in the decades leading up to 2008 was a shift from a bank-credit-based to a market-based financial system; borrowing and lending that had been conducted via customer relationships at commercial banks came, more and more, to be conducted instead via the exchange of securities. The year 2008 can be understood as the first major crisis of this new, market-based financial system. These developments in banking were driven in particular by the rise of money-market mutual funds (1980e). Money funds emerged beginning in the late 1960s, and their usage grew as a response to the demand for high interest rates as compensation for rising price levels in the high-inflation years that followed. They sought to provide the benefits of bank deposits – stable value and ready convertibility into cash – while paying an interest rate above the Depression-era Regulation Q caps, upper limits on interest rates set by the Federal Reserve, that bound commercial banks. They operated as mutual funds, issuing shares and using the proceeds to purchase securities. Though money funds were not insured, as commercial bank deposits were by the Federal Deposit Insurance Corporation (FDIC), they succeeded in displacing the bank credit that had dominated.
As depositors’ business moved from commercial banks to money funds, borrowers’ business moved from commercial loans to commercial paper – short-term securities issued by companies to finance their immediate cash needs. Issuers were able to place their commercial paper with money-market funds, which in their turn needed securities to hold. Bank-based credit was thus displaced by market-based credit; the normal banking transaction was now the issuance of commercial paper matched by the issuance of money-market fund shares, rather than the creation of a bank loan matched by an increase in deposits.
Viewed in the abstract, the two approaches to finance, bank-based and market-based, are not so different. In practice, however, they interacted differently with the institutional environment. One important set of institutional developments was around regulation – indeed the very fact that money funds were not bound by interest-rate ceilings was the main factor behind their growth. Another relevant regulatory shift was the 1999 repeal of the 1932 Glass–Steagall Act, which had kept commercial banks out of securities-based banking. The expansion of market-based credit went along with a general decline in the regulation of the financial system; financial markets were left to their own devices.
A second set of institutional changes relates to the financial usages that supported securities-based banking. One of the institutional advantages of market-based credit over bank loans was that securities could readily trade in secondary markets: the initial purchaser of newly issued commercial paper was not obligated to hold it to maturity, as was the case for bank loans, largely unmarketable. Such markets were made by securities dealers, who bought and sold such securities. The existence of these markets seemed an unmitigated good: knowing that the position could readily be liquidated, potential lenders would enter the market more willingly, and borrowers would benefit from more