The Natural Instability of Financial Markets

This paper contrasts the economic incentives implicit in the Keynes-Minsky approach
to inherent financial market instability with the incentives behind the traditional
equilibrium approach leading to market stability to provide a framework for analyzing
the stability induced by the recent changes in bank regulation to modernize financial
services and the evolution of financial engineering innovations in the US financial
system. It suggests that the changes that have occurred in the profit incentives
for bank holding companies have modified the provision of liquidity to the financial
system by banks, and the way credit assessment has moved from banks to other
actors in the system. It takes the current experience in financial instability
created by the expansion, through securitization, of the mortgage market as an
example of these changes.