By: Elliot Turner
This week, I have been reading Hyman Minsky’s collection of essays entitled Can It Happen Again and came across this very relevant and profound observation:
Financial vulnerability exists when the tolerance of the financial system to shocks has been decreased due to three phenomena that cumulate over a prolonged boom: (1) the growth of financial…payments relative to income payments; (2) the decrease in the relative weight of outside and guaranteed assets in the totality of financial asset values; and (3) the building into the financial structure of asset prices that reflect boom or euphoric expectations. The triggering device in financial instability may be the financial distress of a particular unit.
In such a case, the initiating unit, after the event, will be adjudged guilty of poor management. However, the poor management of this unit, or even of many units, may not be the cause of system instability. System instability occurs when the financial structure is such that the impact of the initiating units upon other units will lead to the other units being placed in difficulty or becoming tightly pressed.
How many have you heard blame Bear Stears, Freddie and Fannie, Lehman, etc? Minsky made this point in an essay first written in 1966, yet it is just as apt in 2010. For investors and traders it is very important to not confuse symptoms and causes. The innate instability in our financial system leading to this crisis was the proximate cause, and the failures of individual units the symptoms. I chose to write up this quote today for today reasons: first, because I am reading the book right now and it’s fresh in my mind; second, I think we are at an important inflection point in the recovery from the most significant post-Great Depression debt deflation.
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