Why capitalism fails

[mike777]

Of course, all the FDIC talk is off-point.  The point of Minsky is his theory that stability is the cause of final instability in a capitalistic system - it is the thought that risk has been conquered that leads to greater and greater risk until instability collapses the entire system.

 

Seem it occurs about every 80 years, if the current collapse is included with the 1929 collapse.

 

The comparisons between 1929 and present day is astounding, btw.  http://www.prospect.org/cs/articles?articl...n_1929_and_2007

I am not quite sure what the heck Minsky is saying......that there is instability, of course there is so?

 

Is he saying there is risk in the system, of course there is so?

 

If he is arguing for more transparencey, who is against that?

[Winstonm]

Btw,

 

Mike is the true "expert" on banking and my knowledge is only based on limited study of finances.

[Winstonm]

Of course, all the FDIC talk is off-point.  The point of Minsky is his theory that stability is the cause of final instability in a capitalistic system - it is the thought that risk has been conquered that leads to greater and greater risk until instability collapses the entire system.

 

Seem it occurs about every 80 years, if the current collapse is included with the 1929 collapse.

 

The comparisons between 1929 and present day is astounding, btw.  http://www.prospect.org/cs/articles?articl...n_1929_and_2007

I am not quite sure what the heck Minsky is saying......that there is instability, of course there is so?

 

Is he saying there is risk in the system, of course there is so?

Mike,

 

I would be shocked if you were not aware of what Hyman Minsky wrote. But for others who may not know, his premise was that stability itself was what led to greater and greater risk taking behaviors - the very stability of the system is what leads to its eventual instability.

 

In this current crisis, I am sure Minsky would have pointed out the banks increasing leverage from 12:1 to 20 or even 30:1, of covenant lite loans, of 100% LTV mortgages, etc., as examples of the increased risk taking behavior.

[mike777]

Of course, all the FDIC talk is off-point.  The point of Minsky is his theory that stability is the cause of final instability in a capitalistic system - it is the thought that risk has been conquered that leads to greater and greater risk until instability collapses the entire system.

 

Seem it occurs about every 80 years, if the current collapse is included with the 1929 collapse.

 

The comparisons between 1929 and present day is astounding, btw.  http://www.prospect.org/cs/articles?articl...n_1929_and_2007

I am not quite sure what the heck Minsky is saying......that there is instability, of course there is so?

 

Is he saying there is risk in the system, of course there is so?

Mike,

 

I would be shocked if you were not aware of what Hyman Minsky wrote. But for others who may not know, his premise was that stability itself was what led to greater and greater risk taking behaviors - the very stability of the system is what leads to its eventual instability.

 

In this current crisis, I am sure Minsky would have pointed out the banks increasing leverage from 12:1 to 20 or even 30:1, of covenant lite loans, of 100% LTV mortgages, etc., as examples of the increased risk taking behavior.

I dont get this......

 

 

This suggests that the investment banks were never stable.......so what is this "stable system"

 

In fact since he studied under "The economic concept of creative destruction was first introduced by the Austrian School economist Joseph Schumpeter.

 

In Capitalism, Socialism and Democracy, Schumpeter popularized and used the term to describe the process of transformation that accompanies radical innovation.[1] In Schumpeter's vision of capitalism, innovative entry by entrepreneurs was the force that sustained long-term economic growth,"

 

However if your point is private companies take increased risk given central government intervention in the markets (see fNMA) I agree. If banks take more risk given access to FDIC (cheap under market loans) I agree.

[mike777]

When I was very very young I was hired by Merrill Lynch....

 

The first week on the job...we all got a huge message saying....M/L would not go bankrupt........this was all about the Hunt silver fiasco.........on week one I found out....this was not a stable business.........

 

 

This was coming from the oil business where the government controlled oil.......and I worked about 5 hours a week out of 40 since they made the business silly easy....

 

 

This was out of my computer job in college where i worked about 4 hours out of 40 since no one understood what I was doing or how long it really took...;)

[kenberg]

I think the meaning of an analysis is often found in the action taken or recommended. The observation, that long periods of relative stability even with the occasional craziness sparked by such things as the Hunt's attempt at cornering silver will likely lead to underappreciation of risk, seems to me to be pretty obvious. A guy is not getting a Nobel prize for noticing this. The conclusions drawn from this observation are what matter.

 

Here is a Longish) quote from the article:

 

 

 

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve - what he liked to call the “Big Bank” - step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke - like Minsky, a scholar of the Depression - it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

 

Minsky’s other solution, however, was considerably more radical and less palatable politically. The preferred mainstream tactic for pulling the economy out of a crisis was - and is - based on the Keynesian notion of “priming the pump” by sending money that will employ lots of high-skilled, unionized labor - by building a new high-speed train line, for example.

 

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

 

While economists may be acknowledging some of Minsky’s points on financial instability, it’s safe to say that even liberal policymakers are still a long way from thinking about such an expanded role for the American government. If nothing else, an expensive full-employment program would veer far too close to socialism for the comfort of politicians. For his part, Wray thinks that the critics are apt to misunderstand Minsky. “He saw these ideas as perfectly consistent with capitalism,” says Wray. “They would make capitalism better.”

 

But not perfect. Indeed, if there’s anything to be drawn from Minsky’s collected work, it’s that perfection, like stability and equilibrium, are mirages. Minsky did not share his profession’s quaint belief that everything could be reduced to a tidy model, or a pat theory. His was a kind of existential economics: capitalism, like life itself, is difficult, even tragic. “There is no simple answer to the problems of our capitalism,” wrote Minsky. “There is no solution that can be transformed into a catchy phrase and carried on banners.”

 

So the article gives two recommended changes from past practice, the first of which seems to be about what the fed actually did. But the article is a brief summary of his theories, and a full reading would no doubt be challenging.

 

 

One point that occurs to me: It has been observed by many that part of the problem was that many of the "risk takers" were actually creating far more risk for others than for themselves. No doubt there should be some correction applied. But Minsky's observation warns that this may not suffice. Having to risk substantial amounts of their own money will slow the action a bit, but the urge may still be irresistible after a long period during which caution seems old fashioned and unnecessary.

 

 

Btw: "Why Capitalism Fails" is a somewhat overstated headline.

[helene_t]

Btw: "Why Capitalism Fails" is a somewhat overstated headline.

Yeah. We have had one year of negative growth and are now back at the same GDB level as in 2006. Or some such. Big deal.

[Winstonm]

Actually, I don't know how anyone knows which banks were bailed out when Bloomberg had to file a lawsuit to try to force this information from the Fed and the Fed responded to the lawsuit by telling Bloomberg that they and their lawsuit could go F#*) themselves.

[Winstonm]

Btw: "Why Capitalism Fails" is a somewhat overstated headline

 

I don't know - I think it is about how you read it (grasp its meaning). I understand it to mean "Why Capitalism Fails (to be the perfect system).

 

I don't take it to mean capitalism fails as in collapses or that any other system is better - although the Libertarians accuse Keynesianism of being closeted socialism.

 

 

Personally, I don't think it is. My understanding is the Keynes principles would certainly use government policy to redistribute wealth temporarily, the key to socialism is government control of production, not simply redistribution of wealth.

 

If redistribution of wealth equated to socialism, then the Reagan and Bush tax cuts have to be viewed as socialistic.

[helene_t]

[....] Libertarians accuse Keynesianism of being closeted socialism.

 

Personally, I don't think it is.  My understanding is the Keynes principles would certainly use government policy to redistribute wealth temporarily, the key to socialism is government control of production, not simply redistribution of wealth.

Keynesianism is the belief that fiscal policies are efficient in regulating growth while monetary policies are inefficient. A Keynesian would respond to an overheated economy by raising taxes and/or cut spendings, and to a recession by reducing taxes and/or increase spendings.

 

This has nothing to do with the income redistribution, and not even with the size of the public sector. It is about the balance of the govt't budget.

 

Of course an extreme libertarian who doesn't want a government budget at all cannot favor a Keynesian policy as an instrument in his ideal society. But he could still believe it to be efficient in terms of regulating growth, and he would favor a Keynesian policy of reduction of spendings or reductions of taxes. And if he doesn't believe in a single central bank with the power to influence interest rates, he cannot believe in monetarism as a political doctrine either.

[Winstonm]

[....] Libertarians accuse Keynesianism of being closeted socialism.

 

Personally, I don't think it is.  My understanding is the Keynes principles would certainly use government policy to redistribute wealth temporarily, the key to socialism is government control of production, not simply redistribution of wealth.

Keynesianism is the belief that fiscal policies are efficient in regulating growth while monetary policies are inefficient. A Keynesian would respond to an overheated economy by raising taxes and/or cut spendings, and to a recession by reducing taxes and/or increase spendings.

 

This has nothing to do with the income redistribution, and not even with the size of the public sector. It is about the balance of the govt't budget.

 

Of course an extreme libertarian who doesn't want a government budget at all cannot favor or Keynesian policy as an instrument in his ideal society. But he could still believe it to be efficient in terms of regulating growth, and he would favor a Keynesian policy of reduction of spendings or reductions of taxes. And if he doesn't believe in a single central bank with the power to influence interest rates, he cannot believe in monetarism as a political doctrine either.

Agreed. Unfortunately, the U.S. doesn't believe in the raising taxes and reduction of spending part of Keynes ideas.

 

However, IMO raising taxes for government decisions on spending is a redistribution of wealth - just as is reductions in high-income taxes being paid for by reduction in benefits in Social Security. (A Greenspan advocated ploy)

 

Redistribution of wealth is a policy decision.

[barmar]

This suggests that the investment banks were never stable.......so what is this "stable system"

That's the crux of the paradox.

 

The point is that it isn't really a stable system, but it goes so long without any severe problems that it seems stable. And that sense of invulnerability is what leads to excessive risk taking, which creates a bubble, and when the bubble bursts you discover that the system wasn't really as stable as the conventional wisdom implied.

 

This is a normal psychological behavior. For instance, I've never gotten the flu, so I don't bother getting flu shots. A big difference is that many economists assumed that businesses and economies were not subject to the same irrational behaviors as individuals.

[y66]

fyi, Dennis Leyden's links to Paul Krugman's June 2009 Robbins Memorial Lectures at the London School of Economics.

 

Good stuff to listen to while exercising. :P

[helene_t]

The point is that it isn't really a stable system, but it goes so long without any severe problems that it seems stable. And that sense of invulnerability is what leads to excessive risk taking, which creates a bubble, and when the bubble bursts you discover that the system wasn't really as stable as the conventional wisdom implied.

 

This is a normal psychological behavior. For instance, I've never gotten the flu, so I don't bother getting flu shots. A big difference is that many economists assumed that businesses and economies were not subject to the same irrational behaviors as individuals.

Maybe I am wrong but I doubt politicians, regulators and academics are better at judging the stability of the "system" than traders are.

 

I once found out that the managers of a hedge fund I invested in got a bonus for large short-term wins but suffered no penalty for large losses. In other words, if they start with a portfolio worth one billion, let it grow to 2 billions the first year and shrink back to 1 billion the second year, they would be awarded. While if they just stay put through the two years they would not. Since then I haven't put money in hedge funds. If I were to invest again in something other than savings accounts and my own house, I would buy shares in real companies.

[kenberg]

i see, following the links, that many LSE lectures can be downloaded. Good grief, I might actually have to learn something. Just having opinions is so much easier.

[Winstonm]

This is from a website called Safehaven.com:

 

Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, like right now, even to companies that can afford loans, and the economy subsequently contracts.

 

I find this interesting as economist Andy Xie has recently described both Japan's troubles, the U.S. troubles, and the future troubles of China as having similar causes.

 

http://www.ritholtz.com/blog/2009/09/andy-...-economy-sinks/

[barmar]

I once found out that the managers of a hedge fund I invested in got a bonus for large short-term wins but suffered no penalty for large losses. In other words, if they start with a portfolio worth one billion, let it grow to 2 billions the first year and shrink back to 1 billion the second year, they would be awarded. While if they just stay put through the two years they would not. Since then I haven't put money in hedge funds. If I were to invest again in something other than savings accounts and my own house, I would buy shares in real companies.

Hedge funds are by their nature exceptionally risky, so it's common for them to lose value. Would it really be fair to the fund manager to penalize him for getting the expected results? I don't know of any type of company that makes employees pay for poor performance, except that they might be fired if they're performing well below expectations. What kind of penalty would you like to see the hedge fund managers suffer?

 

Also, although he makes money if the fund goes up and then comes back down, he makes even MORE money if it grows both years. He has no incentive to let the fund drop in the 2nd year just because he made a bonus in the 1st year. Also, if I'm not mistaken, mutual fund managers compensation is typically tied to the NAV of the fund; when it goes down so does their salary, plus they don't get a bonus, either. Or they're strongly encouraged to invest some of their own money in the fund they manage.

 

It also seems strange that you've sworn off all mutual funds because of problems you see in the most risky category of them.

 

BTW, aren't real company executive bonuses similar to the bonus policy of the hedge fund?

[Winstonm]

The hedge fund compensation historically has been 2 and 20, or 2% management fee and 20% production fee. The fee structure is such that high risk-taking is rewarded while loss is ignored.

 

It's is really quite the confidence game - hey, buddy, give me your money and I'll invest it for you and I'll only charge you 2%, and if we make money I'll only keep 20% of it. Of course, if we lose you still pay me the 2% for talking you into giving me your money and losing it for you.

 

Sweet.

[PassedOut]

As a person in business, I certainly favor a market system with risks and rewards and with incentives for high production and good service. The question, then, is how best to mitigate the negative effects of the system on those who do not wish to participate in the risk-taking, but prefer stability and security.

 

I found it interesting that Minsky addressed that very question in a way that complemented the market system rather than replacing it (which, in my view, would be disastrous).

[barmar]

If you want stability and security, invest in high-grade bonds and other fixed-income securities.

 

When you invest in highly volatile instruments, like hedge funds, they should disclose the risks. The expectation is that they go down often; the hope is that when they go up, they'll go WAY up, and this will make up for the losses. And when they achieve this, it makes sense to reward the fund manager.

[mike777]

If you want stability and security, invest in high-grade bonds and other fixed-income securities.

 

.

of course following this advice in 1970= close to negative 100% return. INflation matters.

 

 

invest 3.000 in 1930...hold for 40 years and collect your interest in 1970 and ?

invest 3000 in 1940 and hold for 40 years and collect in 1980?

 

OTOH buy 5th ave nyc....3000 in nyc and hold for 40 years....

 

OTOH buy chicago....3000 hold for 40 years.....

 

 

Granted risky...you might DIE

[PassedOut]

If you want stability and security, invest in high-grade bonds and other fixed-income securities.

Many people cannot afford to invest enough money in high-grade bonds and other fixed-income securities to weather a period of unemployment caused by failures of the economic system. And many are too young to have established a substantial nest egg even when they have started saving.

 

I can't overlook the hardships caused by the instabilities in our economic system even though my family is lucky enough not to be hurt. I do have relatives, friends, and (of course) potential customers who are badly hurt when when they lose their jobs.

 

We accept that if one of our businesses goes under, we took risks that didn't pay off. It happens. But why should those who simply want to work productively for a predictable salary suffer because some wealthy high-rolling gamblers lose their bets?

 

I don't think that they should, so I think Minsky's ideas deserve consideration.

[luke warm]

We accept that if one of our businesses goes under, we took risks that didn't pay off. It happens. But why should those who simply want to work productively for a predictable salary suffer because some wealthy high-rolling gamblers lose their bets?

 

I don't think that they should, so I think Minsky's ideas deserve consideration.

if a person has the money and wants to risk it in any way s/he chooses, who should say 'no'?

[hrothgar]

If you want stability and security, invest in high-grade bonds and other fixed-income securities.

Stable is not equivalent to secure. (Especially if you're expecting inflation)

 

On the hedge fund front: My understanding is that the apha generated by most funds is unable to compensate for the management fees.

 

Me, I have a nice little portfolio optimization algorithm sitting on my desk.

 

I feed in a set of

 

Sector specific spiders

Exchange Traded Funds for light sweet crude, copper, and agricultural goods

A yen fund and a euro fund

 

Nice, boring diversified portfolio

 

Might not have the glamor of a hedge fund, but the management fees can't be beat

[PassedOut]

if a person has the money and wants to risk it in any way s/he chooses, who should say 'no'?

Indeed. And it's reasonable to say that we "have" the money we are risking in our own businesses.

 

But would you say that a person engaging in highly-leveraged speculation with invested funds "has" the money he or she risks?

 

What we are discussing here, though, is how those who are not participating in the risky speculation should be shielded from the effects of the crash when the speculation goes bad. Minksy offers what seems to me to be at least a partial solution to that problem. Agreed?