Sometime in the 1950s twentieth century economist Hyman Minsky developed his Financial Instability Hypothesis. At the cornerstone, is the notion that economic stability breeds instability. How’s that possible?
As Minsky observed, financial crisis follow periods of economic prosperity. These periods of prosperity encourage borrowers and lender to be progressively reckless. Increased credit and debt lead to inflated asset prices.
Eventually, excess optimism leads to instability…lending and debt move to unsustainable levels. Financial bubbles then burst. Asset prices crash and the mistakes of the preceding boom are corrected.
The housing boom and bust last decade followed Minsky’s script to the letter. A preponderance of cheap Fed credit was emanated into the financial system to soften the dot com crash. For whatever reason, the cheap credit made its way into the housing market.
Early speculators made big returns. Banks followed up the returns with riskier and riskier loans…because, if you recall, ‘house prices only go up.’ Continue reading
