I recently gave an update on America’s economic policy, such as it is, to a group of bankers. I expected a great deal of interest in the Republican tax plan, but instead, they wanted to talk about how costly it was for them to comply with the rules introduced by the Dodd-Frank reform bill.
While sympathizing with their plight — the cost of regulatory compliance has clearly risen over the last decade — I asked them to recall the last financial crisis, a set of catastrophic, deep-recession-inducing events that motivated the creation of Dodd-Frank in the first place.
A few heads nodded. There was some mumbling about irresponsible home buyers.
Add to this anecdote the Trump administration’s attempt to undermine the consumer protection agency created by Dodd-Frank, along with similar congressional actions I suspect you haven’t heard about (I’ll fix that in a moment), and the person this brings to mind is the economist Hyman Minsky.
Perhaps because Minsky, who died in 1996, was both an economics professor and a banker, he understood something other economists assumed away: recurring cycles of financial instability. After a crisis, like the bursting of the housing bubble and its ensuing damage to all the banks involved in mortgage lending (or derivatives of such loans, or insurers of such derivatives — Minsky thought about all this), the financial sector and policymakers are duly chastened. They recognize that risk was systemically underpriced, and they’re even willing to countenance some guardrails against reckless banking and damaging speculation.
Then, a few years into the next expansion, as the memory of the crisis fades, lenders start getting their risk back on. As Minsky observed, this phase is characterized by increasingly exotic and complicated financial tools that disguise the extent of leverage being doled out to borrowers who are far from creditworthy. The next thing you know, you’re inflating the next bubble, which feeds itself until it suddenly pops — a point known as the Minsky moment, when risk-seeking flips to risk-aversion.
- The New York Times