A Flock of Panics and Crises

For those who haven’t seen it already, US News and World Report did a brief piece a short while ago on Minsky’s approach to financial instability.  After running through a list of recent financial panics and crises, Chris Gay notes that from a certain theoretical perspective, this wasn’t supposed to happen.  “This sort of blood-curdling free-fall is supposed to be a once-in-a-lifetime event, like the transit of Venus or a federal budget surplus.  How is it,” he asks, “that someone who was in high school when Justin Bieber was in Pampers has already experienced half a dozen of them? Either we need to redefine ‘crash’ or someone owes you some lifetimes.”  Black swans were once thought by European ornithologists to be rare, until they discovered a number of the birds in Australia.  By contrast, the assumption that financial panics and crises are rare has stuck around, despite more than enough experience with the economic equivalent of black feathers.

In Minsky’s view, financial crises are a normal part of the functioning of this economic system; they are not some deus ex machina that arrives from without to push the system off-balance.  Digesting this way of looking at the stability of our economic system won’t just affect whether we’re surprised when the next panic or crisis comes crashing down on our heads, but also, as Jan Kregel and Dimitri Papadimitriou explain, how we approach financial regulation:

As Minsky emphasized, you cannot adequately design regulations that increase the stability of financial markets if you do not have a theory of financial instability. If the “normal” precludes instability, except as a random ad hoc event, regulation will always be dealing with ad hoc events that are unlikely to occur again. As a result, the regulations will be powerless to prevent future instability. What is required is a theory in which financial instability is a normal occurrence in the system.

For more, the Levy Institute ebook Beyond the Minsky Moment lays out the implications of Minsky’s approach for how we should understand the roots of the recent meltdown and why we can neither settle for Dodd-Frank nor go back to Glass-Steagall. (epub, pdf)