Minsky and Housing Bubble

Dr. Hyman Minsky's explanation of boom and boost in a capitalist economy is based on structure (or rather change of) of financial relationships. It is highly relevant today as it describes what is happening with the housing sector. The practice of ARMs and various option mortgages are nothing but Ponzi finance schemes.

“In order to understand why our economy has behaved differently since the middle of 1960s than it has earlier in the post-World War II epoch we have to appreciate how the broad contours of the financial structure have changed. The changes in the broad contours of demand have changed the reaction of aggregate profits to a change in investment and therefore have changed the cyclical behavior of the ability of business to validate its debts. The changes in the financial structure have increased the proportion of speculative and Ponzi finance in the total financial structure and therefore increased the vulnerability of the financial system to refinancing and debt validating crises.”

“A thorough research study should examine the changing composition of the assets and liabilities of the various sectors and the implications of this changing structure, as well as changes in financing terms, for the cash flows of the various sectors of the economy. The cash flow structure due to liabilities need then be integrated with the cash flow from assets and the various cash flows due to income production. In particular the changing relations between cash receipts and payment obligations and between payment obligations and the margin of safety need be understood.” (page 49)

“The combined effects of big government as a demander of goods and services, as a generator – through its deficits – of business profits and as a provider to financial markets of high-grade default-free liabilities when there is a reversion from private debt means that big government is a three way stabilizer in our economy and that the very process of stabilizing the economy sets the stage for a subsequent bout of accelerating inflation.” (page 56)

“Innovations in financial practices are a feature of our economy, especially when things go well… But each new instrument and expanded use of old instruments increases the amount of financing that is available and which can be used for financing activity and taking positions in inherited assets. Increased availability of finance bids up the prices of assets relative to the prices of current output, and this leads to increases in investment… In our economy it is useful to distinguish between hedge and speculative finance. Hedge finance takes place when the cash flows from operations are expected to be large enough to meet the payment commitments on debts. Speculative finance takes place when the cash flows from operations are not expected to be large enough to meet payment commitments, even though the present value of expected cash receipts is greater than the present value of payment commitments.” (page 66)

“During a period of successful functioning of the economy, private debts and speculative practices are validated.  However, whereas units that engage in hedge finance depend only upon the normal functioning of factor and product markets, unit which engage in speculative finance also depend upon the normal functioning of financial markets. In particular, speculative units must continuously refinance their positions. Higher interest rates will raise their costs of money even as the returns on assets may not increase…

In addition to hedge and speculative finance there is Ponzi finance – a situation in which cash payments commitments on debt are met by increasing the amount of debt outstanding… Ponzi financing units cannot carry on too long. Feedbacks from revealed financial weakness of some units affect the willingness of bankers and business to debt finance a wide variety of organizations… Quite suddenly a panic can develop as pressure to lower debt ratios increases.” (page 67)

Source: Credit Bubble Bulletin, by Doug Noland of Prudent Bear.

Comments

[Save Homeowners]

Housing bubble or not it costed a lot of people a lot of money. When I bought my home in 2006 my loan officer told me that they will refinance me after 12 months is over. I called them back they simply said I do not qualify. I also try cancelling my loan with them in the first week but I could not get a hold of anyone. About 2 months ago I got a call from US Homeowners Assistance. My original rate was at 8.25% they were able to negotiate with my bank and now its 5.5 fixed. US Homeowenrs Assitance told me that I had been a victim of predatory lending and that they were able to show my lend that and now they are working even reducing my balance. Thank go for them. I had contacted many people to fix my problem because I could not afford the payment. But it seems the goverment is finally doing something about it. I will post their address if anyone needs help.