Articles

A Minsky Meltdown?
By John Bogle

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An old story—perhaps apocryphal—tells of the tailor who made his living selling fine silk shirts to the wealthy wizards of Wall Street. When the stock market crashed in 1929, he delighted in their demise. But within a year, his own business, bereft of customers, itself went bankrupt.

The failure of our financial system, as this sad example makes clear, often resonates throughout our entire economy. Today, we already see the profound weakness in our financial sector finding its way into the rest of our economy. And it will be hard for many of our citizens, far less well-to-do than our moneymen and moneywomen, to bear. In 2006, the wealthiest 20 percent of wage earners in Manhattan made some $350,000 a year on average, nearly 40 times the $8,800-a-year income earned by the poorest 20 percent.

In my long career in finance, going way back to 1951, I've now witnessed 10 bear markets (defined as a decline in the stock market of 20 percent or more). The current bear market has been off by more than 50 percent, slightly larger than the 1973–1974 and 2000–2001 crashes. But this decline is the first that I can recall in which the distress of the financial markets so profoundly impacted the real economy of goods and services, of ordinary people, especially those who had no real way to participate in the boom that led to the bust, but who are now paying the penalty for the market's excesses.

What we are increasingly seeing is the verification of "the financial instability hypothesis" put forth by the economist Hyman P. Minsky (1919–1996). In 1992, Minsky warned that "capitalist economies exhibit ... debt deflations which ... spin out of control ... [as] the economic system's reactions to a movement of the economy amplify the movement ... . Government interventions aimed to contain the deterioration [are often] inept in … historical crises."

Minsky concluded that over long periods of prosperity, the economy transits from financial structures that make for a stable system to ones that make for an unstable system—i.e., that "stability leads to instability," largely through what he described as hedging, speculation and Ponzi finance. In that sense, Minsky was a prophet of one of today's economic crises.

Another insight was also prophetic: "Institutional complexity [read: today's collateralized debt obligations and credit default swaps] may result in several layers of intermediation between the ultimate owners of the communities' wealth, and the [business and individual] units that control and operate the communities' wealth."

This separation between ownership and control has now come to pass. In a mere half-century, we have moved from an ownership society (92 percent of all stocks owned by individuals; 8 percent by institutions) to an agency society (24 percent and 76 percent, respectively), a change I've described as "a pathological mutation in capitalism."