A Minsky Moment

The Wall Street Journal has a front-page story regarding Hyman Minsky, whom it labels an obscure economist. The label, obscure, gives the impression of a crank ignoring the collective wisdom of the economics profession. In fact, Minsky’s obscurity owed more to the willful ideological stubbornness of the discipline that wanted to believe in market efficiency.
The article does not really give much detail about Minsky’s work, except to sum it up: “
When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. “This is likely to lead to a collapse of asset values,” Mr. Minsky wrote.”

Minsky was much more subtle, but this thumbnail sketch shows an enormous gap between conventional economics and Minsky. After all, academic economics teaches that markets are efficient. Milton Friedman insisted that Darwinian forces would eliminate inefficient speculators. The remaining speculators would serve to stabilize the market.

Minsky had a small number of economists who understood his message, but almost none of them had any influence within the profession.

One point that would have made Minsky more relevant today would have been the understanding that profit rates tend to decline, at least in the course of the business cycle. As profits fall, investors look to keep earning the same returns. Consequently, they turn to increasingly speculative ventures that promise to earn comparable returns, even though these ventures are more risky. As long as the optimistic expectations are met, investors pour more money into them, and possibly into even more risky investments in hope of a little bit higher rates of profit.

These temporary profits can lead to more spending, reinforcing the confidence of speculators. Eventually, these speculations become increasingly foolhardy. Financial crisis occurs. Everybody learns a lesson, then quickly forgets it; temporary reforms are put into place, then weakened; and soon the game starts all over until finally a subsequent crisis becomes catastrophic.

Lahart, Justin. 2007. “In Time of Tumult, Obscure Economist Gains Currency: Mr. Minsky Long Argued Markets Were Crisis Prone.” Wall Street Journal (18 August): p. A 1.


5 comments so far

  1. Avin on

    Odd though, that the model of a supposedly ‘obscure’ economist forms the basis for one of the most popular books about financial crises. I’m thinking about Kindleberger’s Manias, Panics and Crashes.

    Another interesting application of Minsky’s model was in a book-length study of the collapse of Kredit Anstalt (the Austrian bank) in the 1930s. The author (unfortunately i cant recall his name), applied the model of hedge, speculative and ponzi finance to the bank collapse…


  2. Andy Lang on

    Q: What is it that I knew back in the early 1950’s even before I had any money to invest and a decade before I began my career as an actuary in NY City, and so did large pension funds then, most Treasurers of large corporations discovered a couple of decades ago, a few large corporations, like GM, are just now discovering are necessary for retiree medical programs, many nations are now discovering, and that most individuals and America’s government are totally clueless on?

    A: That when you have long term sizable obligations that cannot be paid from then current revenues, you must save and invest long-term, part of it in equities–the key asset class–and if you do it right, the investment returns will pay the bulk of those obligations. And, if you also do it using an actuarial cost method known as Entry Age Normal, using a publicly available and fully transparent annual actuarial valuation report, the contributions plus the investment returns will precisely pay those promises– and the cost, expressed as a level % of pay from the date either decent pension benefits, including Social Security, or medical benefits too, first begin to be earned (i.e., the Entry Age) the cost for very good pension benefits and for very good medical benefits would be stable in the face of the slow aging of nations and also quite low.

    In fact, that is how you need to fund Social Security obligations and all national medical care obligations.

    The former needs to be done by making sure you have a real defined benefit pension plan, the latter a real defined benefit national health care system–to be more precise, a Universal, Single Payer National Health Care System, that is actuarially advance funded using the Entry Age Normal Cost Actuarial Cost Method and investing part of the assets in equities–in time, once the short term obligations over the next 2-8 years has been taken care of by T-Bills and bonds, the balance in equities, or equity-type investments, ultimately around 60-70% of the total fund.

    America, of course is way behind other nations as it does not even have a national health care system, preferring instead a god-awful wasteful and expensive, mostly privatized system, in which for 65% of the system we pay well over 30% of the $1.3 trillion annual bill to the insurance companies, so they can keep the ones who need the medical care from having it, while charging for risk and overhead and marketing and profit and for rewarding their agents to sell the stuff.

    This compares to the less than 2% we pay for our Medicare program, which consumes around $350 billion annually, or about 17.5% of our total annual health care bill.

    The balance of course is used to pay for the poor, and those with no health insurance—the ones kept from having any by the insurance companies–with Medicaid taking most of that.

    There is good news and bad news here.

    The bad news is that we are grossly inefficient.

    The good news is that we are so grossly inefficient that by making long overdue, necessary and obvious changes, can save many hundreds of billions of dollars annually, enough to actuarially advance fund both Social Security and this new national health care system, cover the 47 million with no health care, so that we can save both systems, have low and stable costs, do so with no additional taxes or cutbacks in benefits, and by so doing also fix capitalism and save democracy at the same time.

    And transport the same actuarial approaches to other nations as well, which will benefit those nations in the same way and the world economy in many powerful ways.

    You gave in effect changed gross inefficiency in our health care system into large national savings and investment, pure gold, the proverbial ‘No Free Lunch’, free lunch–large steady patient capital that can transform and fix some of the more egregious excesses of capitalism, what is now in the dictionary known as ‘Enronization’, making it perform better, as a partner of democratic and activist government, rather than in opposition to it as a large number of fiefdoms opposed to democracy.

    And yes, there is also a way to make sure that ordinary people—the plan participants—own this system, including the assets, by allocating voting shares in proportion to the funded actuarial reserves of the systems, as further and a major check and balance against possible transgressors, including the government.

    Also note that since the maintenance costs, that is the Entry Age Normal Costs, will be very low (ultimately around 3% of pay each for Social Security and this national health care system) the combined employee-employer payroll taxes for both systems can reflect this—but gradually over perhaps a ten year transition period, to allow for the implementation of the all of the health care reforms to take root and save money so as to avoid tax increases elsewhere, such as in the General Account, where the initial unfunded past service obligations will be amortized, that is paid off just like your home mortgage.

    For the kinds of changes, Google Hillary Clinton’s website and her seven areas for improving health care, and the McKinsey companies report of this subject and their seven changes. Both I strongly support.

    Please note that for most of these areas you simply cannot fix them well if at all, with private means—you need a national health care system first!


    The article referenced above indicates, however, that care is in order so that governments do not venture into this whole arena of investing in equities carelessly.

    Unlike what many nations are now doing in investing national surpluses in equities, you need

    O Specific quantitative goals or obligations in mind,

    O To make sure politicians do not muck up the works and instead

    O Use investment experts, rigorously vetted and chosen for past performance and low fees, and then subsequently

    O Monitored for performance in accordance with

    O Your carefully developed long term investment strategy built upon Harry Markowitz Nobel-Prize winning formulas for asset allocation that increases portfolio returns while reducing volatility (The so-called Efficient Frontier), but not being a slave to the math, as the underlying assumptions are always in a state of flux and finally

    O Use the above mathematically and actuarially rigorous methodology, in which the system is self-correcting as you go, and as a whole is also self supporting and is never ever ‘out of actuarial balance’,

    lest you make horrendous mistakes, such as losing your national shirts or causing huge stock market bubbles, which then burst the entire international financial marketplace with such force they will make the Enronization of America and the four trillion dollars lost with the DotCom and telecommunications bust that began in March, 2000, look like a Sunday school picnic by comparison.

    Andy Lang, FSA, MAAA


  3. mperelman on

    I want to thank Andy Lang and Avin for their intelligent comments.

  4. Andy Lang on

    Together, Social Security and medical care are perhaps the third largest problem in the world today, not far behind global warming and nuclear weapons proliferation.

    Even if we should fix both of the first two problems and not fix this third one, you will not like living much in a world bereft of democracies and full of plutocracies and maybe worse.

    Here is how to fix that third problem, globally and not just locally.

    The proper way to fix medical care is to make it a universal, single payer national health care system that is actuarially advance funded using the actuarial cost method known as The Entry Age Normal Cost method, and by so doing invest a portion of the assets in common stock.

    The first part will reduce costs from $2 Trillion annually to around $1.2 -1.3 trillion; the second will reduce costs another $800 billion to bring down the total costs in time to about $400-500 billion annually.

    This is a reduction of 75-80%.

    The first part of these cost reductions will take about ten years but there will be an increase initially of perhaps $150-200 billion for several years before the costs come down, but no tax increase will be necessary if we do this gradually.

    I’m a retired health care and pension-consulting actuary and the only actuary to ever say this. That’s because of massive conflicts of interest in my profession and failure to make actuaries accountable to the public.

    Hillary’s 7 points for health care reform and similar ones by the McKinsey study on health care reform are correct–but they will take a decade to do. Go online and read them.

    As you read them please note that most, if not all, cannot be done unless you have a national health care system–like all other developed and civilized nations have had for years, some for decades.

    This accounts for why their total health costs on a per capita basis are a fraction of ours and why they have had better outcomes in many cases.

    However they too need to actuarially advance fund their systems if they wish to avoid ever-increasing costs as nations age–older people consume more health care and not just a little–a lot.

    One credible estimate, by the employee Benefit Research Institute has that for the US the total health costs at age 65 and over as $1.3 million and that seems to be in right ballpark. For other countries these costs are much lower, but still quite high and they increasing at more than inflation.

    Actuarial advance funding is a little secret that the health insurance industry and my profession do not want you to know. In some cases good health actuaries never learned it in the first place, as it is a byproduct of pension funding and they are two different specialties in my profession.

    For the bad actuaries, after all, if they constructed an sex and age based morbidity table, just as mortality tables were developed some 350 years ago, one might confront the fact that the current system has such high and ever-increasing costs that it is obvious to all, even non-actuaries, that our mostly private system is a joke—60 % of the $2 trillion we spend annually on health care is private and a good part of another $400 billion, another 20%, we spend on Medicaid is too–and thus it is completely unsustainable, and that health actuaries and the companies they work for are the problem and not the solution.

    Some of the larger ones will have an important role in this national health care system but not as insurers, as administrators and watchdogs and to help keep costs down by measuring outcomes and this has to be done by making them not just responsible but most of all accountable.

    Accountability is something they have not been in the past.

    I think only around a dozen or so at most will survive.

    All those little bitty health insurance companies that have been ripping off the public with their individual health insurance policies will die as they should have long ago.

    Lastly, by putting Medicare in legitimate competition with these new health care firms—and require the latter to include everyone and not to cherry-pick—and both will improve—Medicare by becoming more pro-active while these private firms by bringing their much higher costs down—thus benefiting the nation and the people enormously.

    The actuarial advance funding is also necessary to fix Social Security and the source of the additional money will come from these reforms in health care and the monies invested—around $200 billion together—will be a major source of steady patient capital for many decades.

    This will be invested partly in common stock once we have invested enough money for short term cash benefit outflow and this in turn will strengthen our economy in myriad important ways.

    Because of these reforms, no tax increase will be necessary.

    On the contrary, in a decade the annual costs of Social Security and this national health care system will be gradually be brought down to around 3% of pay for each—the combined employer-employee payroll tax. This 3% is the Entry Age Normal Cost.

    The Initial Unfunded Past Service liability of both systems will be calculated by this actuarial cost method and then systematically paid off just like our home mortgages, from the US General Account, and again no tax increases will be necessary–the amounts will come from the aforementioned health care reform.

    Our US firms then will be able to compete far more successfully than they now do with this albatross around their necks.

  5. Orlando Roncesvalles on

    Looks like 2008 onward makes Minsky the smart one!

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