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James Galbraith: How financial stability creates instability

Below are three videos from a talk at the 2009 Economics of Peace Conference in Sonoma, CA, where James Galbraith talks about the Hyman Minsky concept of the instability of stability. This concept is fundamental to the behavioural psychology behind capitalist systems.  This is a case where stability invites greater risk-taking and eventually creates instability. He sees the latest episode of financial crisis as a Minsky moment predicated on ‘Ponzi’-style debt pyramiding that is the end game in the cycle of stability to instability as it was post-1929.

My view is that a lack of regulatory oversight allowed the system to veer away from macro-prudential finance. This is not a case of Madoff-style fraud with everyone in finance cooking up schemes to defraud homeowners. Yes, these cases of predatory lending existed. However, I see the systemic risk as more pertinent.

Systemically-speaking, the Ponzi phase is one of risky behaviour crowding out prudent behaviour in a world free of regulatory controls. If risky behaviour is temporarily rewarded with profit and this temporary period is long enough, then risky behaviour wins and drives out good behaviour. 

In the last few years – even the last few decades, financial interests have used the lack of regulatory controls and increased access to political power to profit using risky financial instruments. They have done so by creating a byzantine maze of Ponzi-style debt schemes (think CDOS levered on mortgage-backed securities or credit default swaps). I consider this looting as it represents a transfer of income. Galbraith calls this the Predator State.

How one deals with the intrinsic instability of capitalist system coupled with the increasing political power of special interests is the fundamental question. The natural tendency toward greater risk in a stable macro environment is toxic when coupled with lax regulatory oversight and crony capitalism. Bailing out the system without punishing the fraud while permitting risky actors and their investors to escape the full consequences of their behaviour is a moral hazard. This invites more of the same in future.

As for the present day, Galbraith talks about government as the cushion between us and Depression. I see this as an accurate view. Whether this is the advisable way forward (i.e. should we take the pain now?), depends on your view on government’s role in the economy. I believe that citizens’ witnessing yet more crony capitalism in this depressionary environment will almost certainly induce ‘big government revulsion’ and lead to a relapse. See my post “A few thoughts about the limitations of government.”

Hat tip Mark Thoma. Running time about 45 minutes in three parts.

(three videos embedded above)

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

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