Anatomy of a typical crisis

A model developed by Hyman Minsky is used to interpret the financial crises in the United States, Great Britain, and other market economies. The pro-cyclical changes in the supply of credit. During the expansion phase investors became more optimistic about the future and they revised upward their estimates of the profitability of a wide range of investments and so they became more eager to borrow. At the same time, both the lenders' assessments of the risk of individual investments and their risk averseness declined and so they became more willing to make loans, including some for investments that previously had seemed too risky.

When the economic conditions slowed, the investors became less optimistic and more cautious. At the same time, the loan losses of the lenders increased and they became much more cautious.

Minsky believed that the pro-cyclical increases in the supply of credit in good times and the decline in the supply of credit in less buoyant economic times led to fragility in financial arrangements and increased the likelihood of financial crisis. The instability in the supply of credit.

Minsky argued that the events that lead to a crisis start with a "displacement", some exogenous, outside shock to the macro system. The boom in the Minsky model is fueled by an expansion of credit.

The nature of the shock varies from one speculative boom to another. If the shock is sufficiently large and pervasive, the anticipated profit opportunities improve in at least one important industry sector.

The boom in the Minsky model is fueled by an expansion of credit. He argued that the growth of bank credit has been very unstable. One central policy issue centers on the control of credit from banks and from other suppliers of credit.

Three types of finance---hedge finance, speculative finance, Ponzi scheme. Hedge finance: anticipated operating income is more than sufficient to pay both the interest and scheduled reduction in its indebtedness.

Speculative finance: anticipated operating income is sufficient so it is abe to pay the interest; but the firm has to use cash from new loans to repay part or all of the amount due on maturing loans.

Ponzi finance: its anticipated operating income is not likely to be sufficient enough to pay the interest on its indebtedness on the scheduled due date; to get the cash the firm must either increase its indebtedness or sell its assets.  

When the economy slows, the original hedge finance firms may be in speculative finance group, and the initial speculative finance firms may fall into the Ponzi finance category.

The term Ponzi scheme now is a generic term for the non-sustainable finance patterns.