Economists Find Another Good Moment to Consider Minsky

American Banker, June 1, 2012. © 2012 American Banker and SourceMedia, Inc. All Rights Reserved.

Hyman Minsky was a maverick economist in his day. He theorized about the inherent instability of financial markets, and viewed the Federal Reserve as the author of both the permission slip and the prescription for economic crises.

None of it sounds very far-fetched now, of course. The Great Recession pulled Minsky’s ideas in from the fringes of the economics mainstream, and turned the late economist’s work into a touchstone for many who have tried making sense of the latest financial crisis. Accordingly, the annual Hyman P. Minsky Conference, where academics, policymakers and assorted market philosophers gather to apply Minsky’s lens to contemporary issues in finance, has taken on special significance since the events of 2008.

This year, the forum focused mainly on the financial reforms underway in the United States, and on the continuing crisis in Europe.

The upshot was that the US banking agencies are making decent, and in some cases helpful, progress in carrying out new duties assigned to them under the Dodd-Frank Act, while the European economy is, and likely will be for the next five to 10 years, a total basket case.

Translation: Minsky was right to eschew the deregulation arguments that most of his contemporaries were making in the 1970s and 1980s, and if it hasn’t been proven yet that markets are inherently unstable, it can at least be agreed upon that they are frequently unstable-and not just on this side of the pond.

But how should that instability be handled?

Joseph Stiglitz, the Nobel Prize–winning economist from Columbia University, argued for fiscal solutions to the persistent US economic malaise, saying, “Monetary policy can’t help now.”

But as Financial Times commentator Martin Wolf reminded the audience the next day, fiscal strength failed to ward off the crisis in Spain and Ireland, which were in excellent fiscal shape right up until their economic booms ended.

Wolf wasn’t responding directly to Stiglitz, but juxtaposing the remarks by the two men, an important question is raised: if monetary policy can only go so far, and fiscal strength can only last so long, what other solution for stability is there?

Better regulation, perhaps. Minsky put more stock in financial regulation than many of his contemporaries did. But even he acknowledged that regulators are poorly positioned to keep up with financial sector innovations-a point driven home whenever the conference discussion turned to the topic of derivatives regulation.

Frank Partnoy, a University of San Diego School of Law professor who used to structure derivatives on Wall Street, was largely critical of the Dodd-Frank Act’s attempts to regulate derivatives, particularly its mandating of centralized clearing for swaps. He said a migration to clearing would have happened with or without the legislation, and that it wouldn’t do much to stabilize the financial system in any case, especially with exemptions being carved out for so many big pieces of the derivatives market. Partnoy readily acknowledged the paradox in his critique, admitting, “It’s sort of like Woody Allen’s complaining that the food is terrible and the portions are too small.”

The challenge of chasing innovation also was addressed by J. Nellie Liang, the director of the Office of Financial Stability Policy and Research at the Federal Reserve Board. In her impressively succinct (and refreshingly apolitical) explanation of what Dodd-Frank does and does not do, she noted the act makes no attempt to control financial innovations, thus ensuring a healthy level of activities in the shadows for some time.

Liang pointed out that most of Dodd-Frank’s accomplishments are of the pre-emptive variety-like prescribing higher capital requirements, establishing a Financial Stability Oversight Council and creating a resolution regime for the largest institutions. Such measures can’t prevent future crises (“Shocks are hard to predict,” Liang noted) but what they can dois “tell you how many people need to be in the room to solve the problem she said.

Christine Cumming, first vice president of the New York Fed, provided some color on one of the most curious pre-emptive measures of all: end-of-life planning for the biggest institutions. She said discussions between regulators and bankers on living wills have been productive, if not easy conversations to have (though certainly easier than they would have been pre-2008, she pointed out).

The living wills required by Dodd-Frank “will not be meet-me-at-the-bridge-at-5-o’clock kinds of plans, but they will be menus of options” for handling a wind-down, Cumming said.

With the worst of the crisis slowly receding into rear view, the atmosphere at the conference was less combative than in past years, when the panels and audiences seemed to contain more, or at least more vocal, critics of banks and bank regulators.

One of the more memorable moments of last year’s Minsky Conference came in a speech by Phil Angelides, who chaired the Financial Crisis Inquiry Commission. He was outraged that former Fed Chairman Alan Greenspan had been in the press that spring criticizing Dodd-Frank. It was Greenspan, Angelides said, who “had his foot on the gas pedal as we drove over the cliff, and now he wants to give the nation driving lessons once again.”

Greenspan’s driving abilities were considered again this year, this time by Bruce Greenwald of Columbia University, who had a much more detached view of the whole situation.

“Alan Greenspan is not a hero. Alan Greenspan is not a villain. Alan Greenspan is irrelevant,” Greenwald said, arguing that by the time Greenspan got “into the driver’s seat,” the steering column already “had been disconnected from the wheels.”

Did this reflect a fundamental difference of opinion, or just an extra year’s worth of hindsight and contemplation as we move farther away from the most acute stages of the crisis?

Maybe both. Dmitri Papadimitriou, president of the Levy Economics Institute of Bard College, which sponsors the annual Minsky gathering, explained the softening in tone thusly: “When you are having a crisis and you don’t see a ready solution to it, you want to put your views forward. There are real problems we haven’t come to a solution to yet … But there is a lot more agreement now.”