Financial Instabilty hypothesis

The recent financial crisis has been a marvel for the posthumous reputation of Hyman Minsky, an economist who remained in the fringes during his lifetime. Minsky said that financial crises are endemic in capitalism. They arise because in times of prolonged prosperity, borrowers tend to become less careful when borrowing and lenders more reckless when lending. Because of that, speculative bubbles arise in the financial system. Whereas before, most borrowers were “hedge borrowers,” that is, they could repay the principal and the interest on their loan from the profits they made; however, progressively more and more borrowers become “speculative” or “Ponzi” borrowers, that is, they can only repay out of their profits the interest on their loan or not even that, in which case they have to sell their own assets to raise money to repay their debt. The problem is that this can drag the whole system down. When “speculative” and “Ponzi” borrowers emerge, the amount of debt in the system soars until it becomes obvious that it cannot be repaid and that someone has to pay the price of this systemic insolvency. “Speculative” and “Ponzi” borrowers then default, lenders tighten the grip on credit, and that drives the economy into recession.