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Introduction: Economic Problem & Impact
The precise economic problem of exacerbated poverty and widening of the gap between
the rich and the poor in contemporary American society is a direct offshoot of the de-regulatory
efforts spearheaded by extreme capitalists in the late 80s. These included Alan Greenspan,
chairman of the Federal Reserve at the helm of affairs and whose reign continued from 1987
over to 2006 in successive four year terms, spanning a total of six presidential terms.
The deregulation of lending institutions was brought about by the belief that extreme
capitalism, in all its characteristics, was somehow a panacea. Selfishness was the greatest virtue
espoused, taken in courage from the writings of Ayn Rand, a mother figure to many of the
policymakers in charge. The credo was, “I will never live for the sake of another man, nor ask
another man to live for mine.” A prominent trading boss famously said, “there’s blood in the
water, let’s go kill somebody”, indicative of the attitudes of the time. Greenspan, an ardent
objectivist and close associate of Ayn Rand, who read Atlas Shrugged while it was still being
written would say in his 2008 testimony before Congress, “I have found a flaw. I don’t know
how significant or permanent it is. But I have been very distressed by that fact . . . Those of us
who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself
especially, are in a state of shock and disbelief.”
According to many commentators, the filing of the largest bankruptcy in US history (that
of Lehmann brothers on the 15th of September, 2008) as an event symbolizing an economic
watershed. The experiment of financial deregulation, for which Greenspan, is most to blame,
was ended that day. It is to be noted that the economic brutalization of classes, a class war
perpetrated by the rich over the poor, using the tools of financial deregulation and unbridled
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capitalism, continued for all this time: a solid twenty years, during which the poverty plaguing
the weaker classes exacerbated actually and the class divide widened (Woodward, 2000).
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The neoliberal ideology that underpinned the chaos concerns most importantly with the
taking away of oversight from financial speculations and investment banking in 1987. State
intervention was realized as importantly needed in the pursuit of social justice, creation and
preservation of stable communities.
Impact
This centralization of greed caused the destruction of the neoliberal capitalist economic
order during the economic recession of 2008-09 and perpetrated the greatest socio-economic
chaos since the Great Depression, depending upon who you ask. Extreme poverty for some of
the increasingly peerless social sectors, that had gradually been rising since the early 80’s,
became exacerbated as millions of jobs were lost. Construction activity stopped in entire regions;
MGM, one of the most prominent builders in the Las Vegas area left several massive projects in
the stage they were. Not only new construction, but existing home sales tumbled. Inventory
levels decreased, businesses put away plans for expansion and thousands were driven to
bankruptcy as credit availability decreased and then froze. Companies, big and small were all
affected, spanning an eclectic combination of industries. The most to suffer were the big ticket
industries that derived out of discretionary portion of customer incomes: cars, rental properties,
vacation homes etc. Trillions of dollars of stock value was evaporated; the negativity had a
domino effect on other economies as well, including the export and savings model economies of
the dependent developing countries, such as India and China.
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The most prominent issue away from the symbolism was the rising inequality between
classes – the poorer were getting poorer, the richer were getting richer. Mason (2008) has cited
figures for the poorest fifth of the American social order. While between the years 1947 and
1973 (when there was regulation and cautionary oversight), the income for this group would go
up by a handsome 116 percent, this growth rate would evaporate into nothingness for the years
1974 to 2004 (a mere 2.8 percent). Neoliberalism as a philosophy was not restricted to America;
in fact it pervaded all of western Europe as well as several asian countries, that adopted it as an
infallible mantra. Correspondingly, in the United Kingdom, the income share begotten by the
lowest 10 percent of the population went down from being 4.2 percent in 1979 to being only 2.7
percent by 2002.
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The second issue Mason puts forth is that of high debt, induced by the use of easy access
to credit cards and debt offerings. Wages and dependence thereon has been reduced
simultaneously. In actuality, the average American man today makes below what he would have
been making in 1979. Incidentally, the lowest 20 percent make even lower than the average
male. Personal debt which was merely 46 percent of the GDP in 1979, today, stands at over 98
percent. Household incomes in UK too have grown at a much lesser pace in the past decades
than in the boom years post World War II. Debt too has increased, following a pattern similar to
the US. It is only our unique system of social security and other welfare schemes that have held
us together as a society in the wake of such an economic disaster.
Thirdly, profits have greatly mapped from the non-financial sector to the financial sector.
Where in 1960, profits of financial firms as a percentage of all corporate profits were merely 14
percent, they are over 39 percent today. This profit is therefore not generated from any
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productive or innovative business. These are more representative of asset bubbles: dot com,
housing and commodity. Speculative capital has been blamed as the cause of ruin for many
companies.
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Peripheral impacts were felt on the social capital, which was eroded to new lows. One
way the impact was felt was via growth in the crime rate in every society in the US. Personal and
financial insecurity increased thus. According to Robert Putnam in his book Bowling Alone,
memberships to voluntary associations decreased all over the nation over the past several
decades, as neoliberalism set in. Murder rates in bigger cities ascended year after year through
metro regions as far apart as New York City, Detroit and Los Angeles (when all the while
forensic sciences ascended to new highs with greater success rates.) Dysfunctional culture
spanned to newer blocks and took on a darker vein. As a society we learnt to not trust each other
and moved farther away, relying on our means (economic means) to tend to ourselves.
The culture of greed and centralization of capital would ensnare previously untouched
commodities, including drinking water and freely available Oxygen. For example, privatization
of water resources in Cochabamba, Bolivia by a consortium (Aquas Del Tunari) of international
companies like Bechtel would lead to one of the biggest and bloodiest riots in the region. Other
aspects of socio-economic upheaval would be seen when a private army of hundreds of
thousands of military contractors was essentially put in charge of the Iraq War. We see the
dissolution of traditional state roles and substitution of them by private actors who are only
motivated by financial concerns. Democratic accountability is lost in each of these episodes of
socio-democratic prostitution.
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Theory: Minsky’s Financial Instability Hypothesis
Hyman Minsky proposed a model of interventionist capitalism, addressing the very
issues that perpetrated the disaster of 2008-09 back in the 60s and 70s (Uchitelle, 1996). The
Hyman Minsky economic model (also called the Financial Instability Hypothesis) – focussed on
the possibilities of a modern financial crisis. Minsky (1919 – 1996) who was a contemporary of
Rand, stood on the other end of the spectrum in his views on control over capitalism. Minsky
predicted the so called “Minsky Moment”: when the capitalistic modern economy would crash
because of the natural course that capitalism according to him is destined to take (Minsky, 1974).
He classes market crashes – which Mason (2008) blames for the social disorder we are living in,
as an “intricate” feature of capitalism. His view was that such a crash would come about when
governments will take a hands off approach to economy and pursue 100 percent employment and
high growth by means of an unfettered and private financial system.
He has been described as a post-Keynesian economist. He was for authoritarian
intervention in the Keynesian tradition, while opposing the deregulation of the 1980s. His model
also does not condone debt accumulation. His theory would stress on the fragility of the financial
markets and dwell on the speculative bubbles (for example real estate, dot com etc) that were
endogenous to such markets over the course of a life cycle.
He said in 1974, “a fundamental characteristic of our economy is that the financial
system swings between robustness and fragility and these swings are an integral part of the
process that generates business cycles.” His claim was that in good times, when the euphoria is
building up, with the rise in corporate cash flow, speculation starts to grow.
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Debts begin to grow over and above incoming revenues and a financial crisis looms. To
save themselves from risk, banks and lenders would stop lending practices and grow reserves.
This starts to contract the economy, because due to the new lending practices, good debtors are
also turned away. This was Minsky’s chief contribution in the 60s and 70s, in that he linked the
financial markets still fairly abstruse, to the state of the economy. Minsky also underscored a
greater role for the federal reserve in his model – principally as a lender of the last resort, helpful
during times of distress.
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In his defense he laid out previous examples where a free market economy had fallen into
cycles of boom and bust, such as in 1907 (“panic of 1907”) and of course during the Great
Depression. Ways that the government could intervene were through increased regulation, action
of the central bank or the federal reserve and through other tools including financial committees
(Barbera, 2009).
Economic Policy Solution of Intervention and Predictions
Minsky’s solution through his model for this inherent malaise in the private financial
sector was socialization of the banking system. Minsky was never opposed to capitalism. Instead
he merely was trying to introduce sustainability in the system. And saving the system from the
periodically scheduled crashes in a high consumption capitalistic economy.
He said, “As socialization of the towering heights is fully compatible with a large,
growing and prosperous private sector, this high-consumption synthesis might well be conducive
to greater freedom for entrepreneurial ability and daring than is our present structure.” Therefore
his efforts were toward strengthening entrepreneurial ability and the basic tenets of capitalism
but not the Anglo-Saxon model of it, where there were no limits to this entrepreneurial culture
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and the associated mindset of freedom from oversight.
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One of the first steps that governments the world over took to stabilize falling economies
was derived in part from the Minsky school of thought. Massive injections of governmental
capital and credit into the system would help soothe nerves. This view was supported by
economists such as Krugman, who labelled it “good deficit” because indulging in such spending
was critical. Not only did it convert the government into a major spender, it also stimulated the
economic environment and encouraged businesses to follow suit. The calls for limiting such
spending were rightfully not heeded. Governments also fostered an environment – through
positive intervention as suggested by Minsky, which would again foster speculative credit and
access to easy credit. Given the gravity of the financial situation, intensive intervention in the
form of a “new global order”, as predicted by Minsky was instituted, in essence a multilateral
crisis resolution mechanism. Therefore a return to capitalism is the solution, however, with a
strong sense of social ethics and responsibilities on the part of the federal reserve.
As an example, Mason quotes William Cobbett on the example of using child labor in
Lancashire in the mid 19th century, “ if these little girls worked two hours less per day, our
manufacturing superiority would depart from us.” Even after governmental intervention and
reforms, when child labor had been banned, capitalism continued to flourish. Around the same
time period, more humanitarian standards were introduced in factories as well. Around the same
time, Britain took increased regulatory measures to ensure that the economy was safe from
financial upheavals. Principle steps taken included the establishment of the powers of the central
bank and the gold standard in legislation. Therefore with new regulations it is more likely that
capitalism will be helped. In any case, letting “the virtue of selfishness” take off is not going to
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be feasible any more.
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A shortcoming perhaps in the model is that the work is entirely theoretical. Minsky never
formulated a mathematical model for his predictions and his espousal was verbal mainly
(Minsky, 1974). This also caused his theories to be sidelined. Mainstream economic models did
not derive from his work; private debt as a parameter has pretty much been excluded, resulting in
loss of linkages between economic conditions and the state of the market. Another post-
Keynesian economist Steve Keen has come up with mathematical models of Minsky’s work
which hold potential. Many of Minsky’s ideas were culminations of thoughts propagated by
Stuart Mill, Alfred Marshall, Knut Wicksell and Fisher.
Practical Applicability & Impact on Market
The crux of the intervention would be to induce minimal and the most important form of
regulation in an otherwise normal capitalistic machinery. This regulation would enable culling of
greed while industry will continue to be driven via profits for that is the central theme of
capitalism. This entails a complex identification of motivations. Ill motivations, that form out of
a quest for profit alone and show apathy for the plight of the system to a certain degree will be
discouraged or clamped upon. Therefore, a holistic spirit for healthy competition without losing
sight of what is important is needed.
Addressing the String Theory
My foremost intervention would be aimed at banks and other lending institutions, who
have thus far used the discretion they have been provided in an abusive manner. Just as it is
important that there are limits on the amount of money they can lend out – which the
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government and the Federal Reserve does using the money multiplication factor, there are limits
needed on the other end of the spectrum as well.
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In slower times, banks have been at discretion to stop lending money. This may be done
when it is perceived that we are at the helm of a recession or when the risk is perceived to be
high or when lending rates are comfortably low – to the benefit of banks. This creates an adverse
situation for the economy though. Besides adversely affecting the credit flow, this practice
reinforces the vicious circle before a recession. Businesses, not able to take credit out, quickly
drop expansion plans or instead may have to sell off assets or lay off people to make ends meet.
Inventory levels drop. A blind and mindless, perceived safety net of reserves has not always
proven to be a protection. We have seen rather large banks in the hundreds declare bankruptcy
during and after the 2008-09 recession. In several cases we have seen the government having to
intervene to provide a safety net as well, both in the US and outside.
The string theory depicts the helplessness of the government at being able to force banks
to lend money. It can merely spur or encourage lending practices by lowering overnight rates,
moves that will release credit, but it cannot coerce them. On the other hand, it is very effective
when it comes to clamping down on the “figurative money” that banks can “create” out of the
deposits via the money multiplier.
Therefore, putting the string theory to rest, there should be a policy that limits the amount
of reserves that lending institutions can sit on. Today, when this credit needs to be released to
valuable debtors, banks are sitting on reserves that are at 50 year highs. This trend is driven both
by discretion and by feelings of fear, that perpetuate our sense of economic weakness in the
times to come. If enacted, this would be a reverse concept to the reserve or monetary ratio, which
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would specify an upward limit to the reserves.
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Passing the Buck Around: Cancerous Loans and Mortgages
First, banks and other lending institutions would not be able to simply shudder
responsibilities. When it has been made clear to them that they cannot simply sell the mortgage
in a secondary market without repercussions – (Bank of America, for example, is being sued for
selling diseased loans in such a fashion) – they will be more likely to take all necessary
precautions in doling out loans. Greed will take a backseat and not everyone will be extended a
loan. That also means that banks would look for able candidates for loans more strongly to get
the credit flowing, something which is in their interest. This will promote market stability.
Billions of dollars worth of bad mortgages that were sold to Fannie Mae (Federal
National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation)
almost caused them to crash for lack of capital and a strong fear of a governmental takeover
loomed. Many of these mortgages were heaped upon the two securitizing giants after they were
offloaded by careless banks in the secondary mortgage market. This included big banks like
Bank of America, Citibank and several others.
Therefore the need of the intervention is specifically to coerce banks to act ethically,
rather than wait to let the situation to get to the point of needing (and expecting) a bailout. There
can of course be quite a few different reasons why this happens. While greed can be managed in-
house, other factors like industry trends, competition between GSEs and MBSs, lax underwriting
standards etc need additional efforts in conjunction with regulatory authorities.
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Underwriting Standards
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As we will see underwriting standards were weakened in a bid to issue more loans and
quickly, specially during the years 2006 and 2007. In a bid to reinvest their own assets toward
renewed lending and reduced thrift reliance, the action of the banks around the time is best
interpreted as pushing mortgages over people who could neither afford, nor need these loans.
Also, around the turn of the century, the banks were trying to improve home ownership rates
within the lower and lower-middle class. Under-served areas were also being given concessions
as a way to make up for past perceived neglect.
These concessions involved low down payment and lower private mortgage insurance to
back those mortgages. Mortgage credit was also being made available continuously even as
conditions for offering them were being changed continuously. This will all lead to the sub-
prime mortgage crisis of 2003-04. Market would shift from the regulated GSE’s and start to shift
toward the mortgage backed securities. These were typically being issued by non-regulated
private-label securitization channels in the hands of private lending institutions.
The more the “mortgage backed securities” became active as a tool of defiance, the lesser
the influence became of the government sponsored enterprise. Private lenders started to wield
power away from the reach of controllers and overseers. The competitive rivalry that erupted out
of this cat and mouse would further exacerbate the conditions for the mortgage industry because
the government sponsored enterprise was undermined from the struggle. Mortgage originators on
the other hand gained in stature. The net effect was that underwriting became lax in a race to
approve and perpetrated one of the biggest reasons behind the mortgage crisis.
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Risky loans were also securitized principally because banks would retain minimum risks,
unlike the government sponsored enterprises that would guarantee how their mortgage backed
security would fare. This risk would be packed away through credit default swaps that allowed
banks and other lenders to sell it to insurance companies and the like. In this transfer, the other
party was not informed, neither could it find out, how risky the actual situation was.
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While it may require intricacies, potential intervention under Minsky’s scheme may come
by way of a process where authorities reserve the right to inspect underwriting work at favored
banks, or develop a co-underwriting profile. These favored banks, in return for allowing the
intervention, would become eligible to apply for a bailout in future.
Maintaining Earnings Level
Maintaining of earnings comparable to industry levels was a chief spur in the gradual but
major shift toward risky mortgages and private mortgage based securities distribution. These
earnings level were hiked during the years 2001-03 when extremely low rates post the dot com
bubble bust had caused a spike in the refinancing numbers. The number of debtors needed to be
expanded because earnings were dependent on that number. This could again happen only with
lax underwriting standards and bringing novelty in offerings. These offerings initially were not
securitized by GSE’s.
As private label securitization commenced and replaced the GSE, the product offerings
turned mainly to more risky, non-traditional, adjustable rate mortgages that were not amortized
from being fixed rate and amortizing. Shareholder pressure ensured that practices continued and
also forced the PLS to assume a sharp growth rate in order to acquire a greater share of the
market. GSE’s too loosened their own standards to compete in time with the PLSs. Companies
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like Ginnie Mae and the FHA, wholly owned by the government continued to lose market share
because of their maintenance of traditional standards and were unable to maintain earnings
levels.
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By 2006, this surplus availability of cheap housing finance, led in part from the growth of
PLS and reduced regulations, would cause a foreclosure crisis owing to the adjustable rate
mortgages. Increased payments would have people, specially ones with bad credit, abandoning
mortgages. The number of foreclosures would decrease home prices and add to the pool of
properties having difficulty being picked up because banks were starting to tighten lending
standards in the wake of defaults. GSEs were starting to be hurt from not just defaulters, but also
the falling property prices.
In spite of government reassurances and a host of measures taken, the damage had been
done by then. The Treasury department was allowed to purchase GSE stock while Fannie Mae
and Freddie Mac were brought under the wings of the government; too big to fail, they were
granted access to lower interest rates at the Federal rates to level the playing field against
commercial lenders. But by August, 2008, almost 90 percent of the share value of both
corporations had disappeared. This crash would leave the poorer, poorer, as they were shunted
out of their homes, unable to make payments against the hiked interest rates, saddled with
mortgages they should not have received in the first place.
Intervention at a deeper level that can clamp down on any unhealthy competition
between the government sponsored enterprises and the private label securitization need to be
eliminated. Proper regulation aimed at curbing on shareholder pressures and just unethical
lending in general is very important.
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Minsky-capitalism
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Minsky-capitalism is a term coined to be interpreted as a sober form of capitalism,
without the malaise of evil, driven by greed and putting benevolence in its right place. Bringing
regulation back into banking and introduction of such steps as 1) regulation of credit card debt
and limits upon the dues against sums borrowed, 2) Limit upon interest that may be charged
upon late payment and term of loan, 3) Transparency in declarations, 4) reestablishing a system
of meritocracy much like India, China and Singapore, 5) treating sums offered for educational
purposes not as loans but as subsidies, gradually abridging the gap between the rich and the poor
via meritocracy, will only enable capitalism. At the same time, more has to be done to bring the
welfare and social security effort up to par. For example, abuses in the welfare system must be
investigated and checks introduced.
The American society is in need of a major uplift effort to bring all of the diverse aspects
of it together. The tradition of care has been weakened and social values have been eroded to
new lows. Economic policy alone will not suffice because the drivers of our economic system
are greed driven and inured in immorality. Therefore a commensurate social response is needed
as well.
Conclusion
The year 2008 proved once and for all that unbridled capitalism has no long term,
sustainable remedy for our economic system. Hymen Minsky claimed that the market structure
as such will be characterized by bubbles of speculation followed by depressions, and therefore
regulatory intervention was much needed. We saw the scenario exacerbated in 2008 because of
the deregulation of banks back in the 80’s. Governmental intervention will be needed and as
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much is amply clear – repeatedly after each bubble has burst. Just so they maintain a tepid
presence at all times is far better and less alarming, than them bailing out behemoth banks and
printing moneys to spur spending all at once. Greater regulation which is not discouraging,
aimed at disciplining the process is not a step backward, but enable stability in our economy and
society consequently.
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