The work of the late economist Hyman Minsky has become increasingly relevant in recent years, as his understanding of the fragility of financial markets and their role in bubbles and busts was both deep and prescient.
Other economists generally viewed financial markets as playing not much more than an intermediary function, passively allocating excess savings to their most productive uses—in fact, many still see it that way. It’s one reason why virtually all business cycle modelers, including those at the Fed, didn’t see the great recession coming—their models either left out or underweighted the impact of the financial sector on the broader economy.
But a key Minsky insight, explained very readably here by John Cassidy, is that there’s a financial cycle within the business cycle, which basically goes from over-pricing to under-pricing risk. Caution yields to euphoria, hyper-cautious risk aversion to incautious risk seeking, and what I’ve dubbed the economic shampoo cycle—bubble, bust, repeat—is underway.
These thoughts came to mind as I read two articles over the past few days. The first describes what looks like a sharp uptick in merger activity, as debt is cheap, corporate earnings are strong, and “animal spirits” among the investor class, if not the middle class, are high and rising. The second is more of a microcosm; it’s a description of a hostile takeover bid by a hedge fund. The deal fell apart, but the hedge fund still walked away with over $2 billion in profit (the fund bought 10% of the target company’s stock, which rose sharply when a higher, rival bid was made).
Neither of these stories are obviously problematic (though the latter tells you a lot about our current inequality problem). A characteristic of the Minsky cycle is pervasive, diffuse credit, juiced by sloppy underwriting and “innovative” financial products, to borrowers who cannot realistically service the debt they’re taking on. The housing bubble is the classic example as its sustaining mechanism was ever-rising home values, since that was the only way many borrowers could pay their mortgages (by borrowing against their appreciating homes).
I don’t see that yet. These deals seem largely restricted to Wall St. as opposed to Main St. And many other signals show the US economy to be uniquely strong relative to most other advanced economies: GDP and job growth are solid if not flashy, household balance sheets are back to pre-recession, pre-leverage levels, and while interest rates are low (as they should be—there’s still too much slack in the economy), I don’t see a credit bubble.
But I suspect up there in economists’ heaven, Hy Minsky read the same articles I did—he probably called Keynes over to have a look—and raised an eyebrow. And when Minsky raises an eyebrow, we should all get a little nervous.