Financial Crashes by Economist Hyman Minsky
Economist Hyman Minsky created the hypothesis on financial instability. He said that in capitalism, the financial crisis became inevitable because cycles of economic growth enabled investors and lenders to be increasingly irresponsible. The excess confidence causes financial bubbles and leads to an eventual bust. Capitalism is, therefore, vulnerable to moving from times of financial stability to uncertainty. This is a kind of business loss and needs control of the government.
How markets vary from stable to instable
Bank funding is typically protected against the collateral. The lending should be hedged against default. For example, banks lend mortgages because customers can collect a deposit to manage mortgage payments to cover both the cash and interest. Typically, banks also test stringent loan requirements to make sure the mortgage is reasonable.
Nevertheless, as house prices increase and economic growth happens, all lenders are investors that are more confident and able to take higher risks. Banks are keen on smaller deposits and able to lend larger income multiples.
We might call the emotions related to lending as ‘irrational exuberance’. There is a perception that the audience cannot be wrong.
Connotation of the Theory of Financial Uncertainty
In his hypothesis, Financial Crashes by Hyman Minsky concluded that since capitalism is vulnerable to the volatility, government control needs to be used to eliminate financial bubbles. It states that:
- The regulation will prohibit fraudulent lending and Ponzi lending.
- Bank specifications hold a minimum volume of equity in cash reserves.
- It is required by banks to lend during boom years to a stability fund that is to be used in periods of recession.
- Strict mortgage loan conditions, i.e., not accepting self-certification mortgages, interest-only mortgages, etc. Ability to respond to asset price increases, e.g., increasing interest rates when there are excess increases in house prices.
- Dividing banks into conventional saving units and riskier venture banking.
- A strong Central Bank ready to serve as a last-resort lender.
Economic uncertainty and a lack of credit
Mainstream economics over the 1970s and 1980s largely overlooked Hyman Minsky’s work. Alternatively, financial reform has seen broad popularity. However, unsurprisingly, the credit crisis of 2007 onward has generated renewed interest in his work.
- The shift from hedge loans to speculation and Ponzi loans, best exemplified by America’s subprime mortgage loans. The enhanced asset prices (especially house prices) above the long-term income ratios.
- Raising confidence in rising asset values, and ongoing economic growth.
- The illusion that we saw the boom and bust process end.
- Credit rating firms struggle to consider the risk of packages of mortgage debt properly.
- Commercial banks’ ability to borrow money on the capital markets to make for more competitive loans
Hypothesis limits in determining financial certainty
Financial-market regulation is far more complicated in practice than in principle. Financial companies have forms to escape government oversight. Regulators struggle because they are trapped in the same ‘irrational exuberance.’
Conclusion
Financial instability arises when issues (or questions about possible problems) within economies, industries, payment processes, or the financial environment arises. These issues usually substantially affect the delivery of credit intermediation services-to have a substantial effect on the planned course of real economic operation.
