The financial distress of the last two decades has revived interest on the quiz, of the stability of the financial system. On the one hand, the "pessimist" view, linked primarily with Minsky argues that not only that the financial law is prone to such crises ("financial fragility" in Minsky's terms) but also that such crises are inherent on the capitalist law ("systemic fragility"). On the other hand, the monetarists see the financial law as stable and productive where crises not only are rare but also are the fault of the government rather than the financial law as such. For many others, however, financial crises may be largely attributable to the financial law but they are also neither unavoidable nor inherent in a capitalist economy.
Therefore, the issues we have to seek here are how base are such crises from a purely historical perspective; to what extent we can identify a base pattern between all crises which would propose an endogenous process that leads to crises; a theoretical framework which explains both the process and the frequency of such crises and ultimately seek the extent to which these financial law characteristics that make it prone to crises are inherent on the capitalist system.
The first question, i.e. The frequency of financial crises partly depends on our definition of crisis. A financial urgency has been defined by Goldsmith as "a sharp, brief, ultra-cyclical deterioration of all or most of a group of financial indicators - short-term interest rates, asset (stock, real estate, land) prices, market insolvencies and failures of financial institutions". The quiz, here is of what intensity and/or intersectoral spread should a financial disturbance be in order to be determined a crisis.
In any case, it appears that though major crises important to the (near) collapse of the financial law are quite rare (the only one being 1929 in the Us), more moderate ones are frequent adequate to allow the seminar that the financial law does suffer from a unavoidable degree of fragility. In the post-war period, after an roughly perfect absence of crises until the mid 60's, the financial law has been at strain on many occasions together with the 1966 prestige crunch, the 1969-70 and 1974-75 crises, the 3rd world debt problem of the early 80's and the stock shop crash of 1987.
Again a casual consideration of financial crises will find a wide range of different causes and forms as each urgency seems to have occurred in response to a unique set of accidents and unfortunate coincidences. But quoting Kindleberger "for historians each event is unique. Economics, however, maintains that unavoidable military in society and nature behave in repetitive ways". Indeed, it is not difficult to distinguish a rough pattern which has been graphically presented by Minsky : crises tend to occur at the peak of the company cycle following a period of "euphoria."
This has probably been initiated by some exogenous shock to the macroeconomic law ("displacement") which results in new profit opportunities. The boom is fuelled by an expansion of bank prestige as new banks are formed, new financial instruments are introduced and personal prestige covering the banks increases. During that period there is broad "overtrading", a not very clear belief which generally refers to venture for a price rise, or an overestimation of prospective returns due to euphoria. This stage is also often referred to as a "mania" emphasising its irrationality and "bubble" predicting the collapse.
Eventually, some insiders resolve to take their profits and sell out and the increase in prices begins to moderate. A period of "distress" may then occur until speculators realise that the shop can only go downwards. The urgency may be precipitated by some definite signal such as a bank or firm failure or a revelation of a swindle; the later are quite frequent in such circumstances as habitancy try to escape the imminent collapse. The rush out of the real or long term assets ("revulsion" in Minsky's terms) lowers the prices of these real assets which were the object of the venture and may found into a panic. The panic continues until either the price falls so low that habitancy are tempted to keep their illiquid assets or a lender of last resort intervenes and /or manages to convince the shop that money will be made ready in adequate volume to meet the quiz, for cash.
Minsky, unlike many others who otherwise accept much of his model, believes that this process will all the time consequent to a crisis. Minsky classifies the quiz, for prestige to "hedge finance" when cash receipts are startling to exceed the cash payments by a requisite margin, to speculative finance" when, over some periods, startling earnings are less than payments and to "Ponzi finance" when the payable interest in the firm's commitments exceeds its net earnings cash receipts; thus a Ponzi unit has to increase its debt to be able to meet its commitments. Once the Ponzi finance situation becomes general, a urgency is inevitable. Others, however, believe that there are ways to forestall Ponzi finance from becoming too widespread.
This model described above implies that crises are in part endogenous and in part outcomes of exogenous disturbances. either this conclusion supports the "financial fragility" view depends on the weights given to the disturbance and the endogenous part of the process. If the shocks requisite to set off this process are of exceptional size and rare then obviously the financial law can be belief as stable. no ifs ands or buts it has been suggested that the new crises have in fact showed the resilience of the financial law against huge adverse shocks. If instead the speculative military are triggered by even relatively small shocks we can then blame the financial law even if the shock were exogenous.
This is both an empirical and theoretical issue. Empirically the euphoria-distress-revulsion process seems to conform with the taste of many crises such as the 1929 stock shop crash, though many others have not gone straight through the whole process. Theoretically, we have to expound the assertions of the above model, namely for the existence of venture and other "irrational" behaviour as implied by "manias" and "overtrading".
Friedman rejects the belief of destabilising venture wholly as a destabilising speculator who bought when the price was rising and sold when it was falling, would be buying high and selling low so that he would be losing money and fail to survive. The rejoinder may be that we can distinguish in two groups of people: the "insiders" who are rational and possess a lot of information and the "outsiders" who may not be "fully" rational and/or not possess adequate information. In such a world, the insiders have incentives to infer and gain at the price of the outsiders. We may also distinguish in the 2 phases of the bubble, a first "rational" one based on "fundamentals" and a second where agents' behaviour is best described by 'mob psychology'. Other possibilities are that agents may pick a wrong model of the cheaper or fail to anticipate the quantitative rather than the qualitative reaction to a unavoidable stimulus, especially if there are time lags.
The question, however, is either outsiders learn by taste though it can be argued that in rapidly changing complicated financial markets such studying may not be very effective. Still "euphoria" arguments may be a miniature naive when applied, for example, to contemporary bankers who have entrance to a wealth of sophisticated advice. no ifs ands or buts a annotation of the Minsky model is that though it might have been true of some earlier time, it is no longer so as big unions, big banks, big government and speedier communications have improved the stability and efficiency of the system. Hansen similarly argues that since the mid 19th century the main outlets of finance were the industrialists rather than the traders and merchants reducing the instability of credit. As we shall see later on, especially after the new deregulations such arguments are questionable.
The monetarists further object to this law because they argue that we should distinguish between "real" or "true" crises which were caused by changes in money furnish and "pseudo-crises" which were not. For example, Friedman has argued that the 1929-32 urgency was largely due to a fall in the money supply. There is miniature reason, however, why the furnish of money is more than an element in financial flows and stocks and no ifs ands or buts Friedman's explanation of the Great Depression has been challenged.
Minsky has further argued that the fragility of the financial law relative to disturbances and speculator behavior depends on three factors: the mix of hedge, speculative and Ponzi finance in the economy, the levels of liquid asset holdings (what he calls "cash kickers" and Margins of Safety) and the way used to finance Investments of long gestation. He further argues that inherently and inevitably the capitalist law will consequent in the worst combination of the above as far as financial stability is concerned. Minsky bases such conclusions on what he calls a "Wall road economy" paradigm as contrasted to the essentially barter cheaper of the neoclassical paradigm. Minsky in fact traces his views on Keynes who also expressed his concern for an increasingly speculative and unstable financial law governed by animal spirits.
In an initially robust financial system, he claims, agents will overestimate the stability and success of the law and will increase their indebtedness (an "euphoric economy"), so that speculative finance will come to be the norm. Similarly overconfidence will make agents cut their Cash Kickers although such margins are crucial for speculative finance units. These mean that the cheaper and the financial law come to be very sensitive to variations in interest rates. Finally, venture projects which have a long gestation period can be financed either sequentially or by prior financing. For similar reasons agents generally chose the risky way of financing projects sequentially which not only further increase the interest sensitivity of the financial sector but increases the volatility of interest rates themselves as they imply an inelastic quiz, for finance given sunk costs plus inherent effects in the real cheaper straight through falls in combination Demand. This, however, does not sound a very robust seminar as one would expect that as Wallich argued, once the law becomes fragile, the agents will get scared and reverse the trend towards speculative finance.
Moreover, the Stiglitz paradox argues that destabilising venture is an inherent characteristic of the system. A financial law is an information infrastructure and as any infrastructure being a public good poses problems in being paid by the price system. Hence "noise" is needed to remunerate active financial markets.
Here we could also mention that many of the disturbances which cause financial crises, may in fact, be endogenously caused by the capitalist system. Nevertheless, this seminar cannot be stretched too far and on the other hand one could attribute the apparent greater instability of the financial law the last 2 decades to the hardships of the real cheaper (oil price shocks, stagflation). In this later case the financial law emerges as particularly resilient , no ifs ands or buts more so than the real economy. Indeed, many habitancy such as Kindleberger, believe that financial disturbances are neither inherent in the law nor is it unavoidable that they will found into crises. Most merge on the issues of acceptable monetary policy, regulation buildings and lender of last resort facilities.
Monetarists obviously preserve that a monetary rule is adhered though others, together with Minsky, fear the consequences of high volatility of interest rates. The lender of last resort premise has generally proved to be quite productive in preventing financial collapse throughout the post-war period. The problem, however, is that it creates a moral hazard problem as agents are encouraged to be more risky. This problem may increase in significance in the future as the significance of the market banks relative to other financial institutions declines and for most of these institutions the moral hazard costs are determined to be much higher and lender of last resort protection is not generally widely ready to them. Also in our increasingly globalised financial system, there is none no ifs ands or buts able and willing to play the role of the international lender of last resort; the collapse of 1929-32 is often partly attributed to a similar lack of lender of last resort as Britain was unable to play this role anymore and the Us were unwilling.
The broad deregulations of the last two decades have also attracted attentiveness regarding their consequent on financial stability. On the one hand, it is argued that the subsequent rationalisation not only increased efficiency, the quality and the range of financial services but helped stability as well by for example allowing a great funds of risk towards those who can bear it more easily. Others, however, point to the increased difficulties for conducting monetary policy, the increase in indebtedness, the increase in prestige risk as company finance shifted towards securities and the greater relaxation in speculative behaviour.
Furthermore, as Kaufman feared, wholly liberated markets will increase instability by allowing crises to quickly spreading to other sectors and countries. In many respects, the Savings & Loans debacle is typical of the problems of deregulation: Though most habitancy would agree that deregulation was long overdue, its timing (coincided with a urgency in the S&L business which encouraged speculative behaviour) and the easing of "safety-and-soundness" regulation proved catastrophic. no ifs ands or buts there is a requisite group of economists who while preserve deregulation, strongly propose the imposition of restricted protection and soundness regulations to increase the stability of the system.
If straight through either of the above instruments, crises can relatively no ifs ands or buts be prevented or stopped then it is clear that they are much less dangerous and less important. Indeed, since one could contain such government actions as part of the actual financial system, then one could quit that the law endogenously prevents crises from occurring.
Concluding, I believe that the financial shop has in fact shown noteworthy resilience and adaptability in the face of the condition of the real economies, the shocks experienced and the rapid deregulation. The issue of financial instability is and should be a concern but probably the best policy towards that objective is to have a wholesome and stable "real" economy. How to perform this is no ifs ands or buts another question.
It may be beneficial to summarize the argument. A law of financial regulation was crafted out of the financial turmoil of the 1930s. It had two defining characteristics, the restriction of competition and government protection. This institutional buildings was created in conformity with the concrete conditions at the time (low debt, high liquidity, low inflation, and low interest rates). It was successful in the postwar period in the United States in part because of that conformity. The high profit rates in the early postwar period also helped to create a situation in which no financial crises occurred.
Eventually, however, those conditions changed: debt increased, liquidity declined, profits fell, and inflation and interest rates increased. The worsening financial conditions in the later postwar period contributed directly to the reemergence of financial crises. The old institutional structure, rather than important to stability and profitability for financial institutions, resulted in instability and financial difficulties in the context of these new conditions. Banks and thrifts found themselves in a difficult situation intensified by the tight monetary policy starting in the early 1980s. Financial crises increased, as did failures of thrifts and market banks. Finally the banks and thrifts searched for riskier, potentially more profitable, but ultimately more speculative areas of lending.
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