"The Transition to a Market Economy: Financial Options"

The social transformation of Eastern Europe has proceeded much faster, and the destruction of communism's legitimacy and efficacy has been more complete, than was deemed possible even a few years ago. A common tenet among the economies now emerging from communism is the lack of significant private wealth, even though there are capital assets that are used in production and have the potential to generate profits. However, since there is no relevant history of profits in the emerging economies, there is no way to meaningfully assess values of capital assets. The financial system provides for linkages through time: Exchanges of money for well-defined claims to future-money flow are made daily. Thus, the financial structure and the physical capital assets of a capitalist economy link the present and the past to the future. The options available to the emerging economies with respect to their financial structure are limited-the lack of significant private wealth leads to weak market for financial instruments and poor prospects for market-based financing. The initial choice of a financial structure is constrained to universal banks or public holding companies. Special venture capital holding companies and local independent banks should be integrated into the financial structure to facilitate entrepreneurial spirit. The public holding company is favored as a transitional instrument to foster the development of information and private wealth, and should be modeled after the Reconstruction Finance Corporation of the New Deal era.

"The Financial Instability Hypothesis"

The Financial Instability Hypothesis (FIH) has both empirical and theoretical aspects that challenge the classic precepts of Smith and Walras, who implied that the economy can be best understood by assuming that it is constantly an equilibrium-seeking and sustaining system. The theoretical argument of the FIH emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system. In spite of the complexity of financial relations, the key determinant of system behavior remains the level of profits: the FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated. Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a "deviation-amplifying" system. Thus, the FIH suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable). The FIH is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles of history are compounded out of (i) the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.

"Finance and Stability: The Limits of Capitalism"

Once again the United States economy is facing a crisis, resolution of which first requires the realization that there are many types of capitalism: Solutions implemented in the past, therefore, may or may not be an appropriate solution today, as they could have been implemented as an answer to a problem posed within the context of a different model. Alternatively, the solution may lie in the implementation of a totally new economic regime in answer to reoccurring problems inherent in capitalism in general. The implementation of a new model is not a unique happening in United States economic history. The interventionist model-set in motion by President Roosevelt in answer to the failure of the laissez-faire model in the 1930s-dealt with the obvious flaw inherent in capitalism in general namely, its inability to maintain a level of aggregate demand consistent with full employment. Implementation of the interventionist model prevented a massive depression of the type experienced in the 1930s from being repeated due to the larger role played by the government sector in maintaining demand via active fiscal policy, while moderating inflation through the use of monetary policy. The interventionist model also recognized the less obvious, deeper flaw of capitalism-namely, the manner in which the financial system can adversely affect the price of assets relative to that of current output. Absent any interventionist policy, the resulting decline in private investment and profits leads to a downward spiral and collapse of the financial sector. The institutional roadblocks included in the interventionist model were sufficient to avert large disequilibriums in asset and output prices, thereby sustaining profits and precluding a deep recession. (Indeed, the Federal Reserve was not forced to act to avert a financial crisis until 1968, when problems arose in the commercial paper market.) The interventionist model, however, was abrogated during the 1980s with the reinstitution of a new laissez-faire model. The new model eliminated many of the restrictions imposed on financial sector, massive increases in national deficits through unproductive public sector spending (made even more inefficient by the resulting interest on the debt), and the growth of speculative financing schemes that left us with too many highly indebted firms. A large, financially induced depression was contained only through the reintroduction of massive governing monetary and fiscal intervention in the form of the S&L bailout and the maintenance of profits with massive deficits. Although the subsequent drop in interest rates has resulted in a rise in asset values and somewhat abated the turmoil in the financial markets, the economy continues to stagnate.

"The Capitalist Development of the Economy and the Structure of Financial Institutions"

This paper evolves from the sharp contrast in Smithian and Keynesian views about the relationship between the financial structure and the economy. The Smithian perspective implies that the financial structure is irrelevant, whereas the Keynesian position concludes that effective financing is necessary for the "capital development of the economy"- there is also a need to constrain any tendency of what Keynes referred to as speculation to dominate. Thus, the essential elements of equilibrium in Keynesian theory, the financial theory of investment and the investment theory of business cycles, are most apt when examined as outcomes of processes that operate over time. During the 1980s, there was a sharp increase in speculative financing resulting from the trend toward leveraged buyouts and the rising demand for short-term marketable corporate liabilities. A main characteristic of a capitalist economy that is stagnant or immersed in a depression is that the capital development of the economy is not progressing. The 1980s were filled with examples of financing inept investments, while the current climate is one of grossly inadequate investment levels to create a progressive full-employment economy. The financial instability interpretation of Keynes rests upon the profitability of debt financing, and incorporates the potential collapse of asset values in an environment of speculative and Ponzi financing. Consequently, the financial structure is significantly more fragile today than earlier in the post World War II era.

"Market Processes and Thwarting Systems"

This paper suggests that there are two longstanding views on business cycles and economic dynamics: One emphasizes endogenous stability plus exogenous disturbances, while the other focuses on endogenous instability plus institutional 'containing' or "thwarting" mechanisms. The latter tradition regards business cycles and economic instability as the natural and inherent consequence of self-interest-motivated behavior in complex economies with sophisticated financial institutions. In fact, it is the interaction between the system's endoge-nous dynamics and the effects of institutions and interventions which, if "apt," constrains the outcomes of capitalist market processes to acceptable outcomes. The endogenous instability view of the economy, in which institutional structures and interventions stabilize the fragile, essentially refutes Lucas: He asserts that the economy is a mechanism that transforms exogenous shocks (either random or unanticipated policy interventions) into business cycles, thus generating a growth equilibrium. Recent history has illustrated the flaws of laissez-faire theory as the postwar capitalist economies that have enjoyed consistently high levels of growth are big government interventionist economies. The challenge for the future is recognizing that market processes are deficient not only in their ability to maintain aggregate demand, but also as devices for assuring productive investment and a tolerable distribution of income.

"Securitization"

"At the annual banking structure and competition conference of the Federal Reserve Bank of Chicago in May 1987, the buzzword heard in the corridors and used by many of the speakers was 'that which can be securitized, will be securitized.'" So notes Hyman Minsky in a prescient memo on the nature, and the implications, of securitization, written 20 years before an explosion in the securitization of home mortgages helped create the current financial crisis. This memo, which served as the basis for a lecture in Minsky's monetary theory class at Washington University, has not been widely circulated. It is published here in its entirety, with a preface and an afterword by Senior Scholar L. Randall Wray that places Minsky's work in context.