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Market Failure Cannot Be Resolved Without Regulation

Angry Bear

Posted by Dan Crawford (Rdan) | 11/24/2010 10:54:00 AM


Matthew Richardson, a professor at NYU Stern School of Business, offers his thoughts on risk management and the economy.

Market Failure Cannot Be Resolved Without Regulation

Matthew Richardson on November 23, 2010, 12:00 AM

I am all for free markets and not mucking them up with government intervention. But the economic theory of regulation tells us that if there is a market failure, it cannot be resolved privately. The public sector must get involved.

The most illustrative examples of such failures in U.S. financial markets were the frequent financial panics from the 1850s until the Great Depression. Those episodes taught us that when illiquid, asset holdings (e.g., loans) of the financial sector are financed short-term (e.g., by deposits), and are hit by a severe macroeconomic downturn, failures of financial firms can lead to system-wide runs on deposits. This in turn leads to a massive disruption of the system that provides credit to households and corporations. When economists bandy about the term systemic risk, this is the type of event they are referring to.

The market failure here is that, although each financial institution may have been behaving optimally on an individual basis, the firm had no incentive to take into account the effect of their actions on the system as a whole. In economics, we call this a negative externality and it is analogous to an industrial firm causing pollution. In the example above, financial failure of one bank increased the possibility of runs on other banks, leading to the system-wide collapse.

The government regulation to address the market failure in this case was to insure retail depositors against losses (today’s FDIC guarantee), thus stopping the cycle of bank runs. Of course, these government guarantees came at great cost, not least the resulting moral hazard. So the government had to enact offsetting regulation and charge banks premiums for deposit insurance, restrict them from certain risky activities, and subject them to prompt corrective action.

This served financial markets well for over a half century. As time passed, however, the regulation became antiquated. Over the last two decades, deposit premiums became mispriced, some financial firms like Fannie Mae and Freddie Mac grew so large that they became too-big-to-fail, and shadow banks—banks such as off-balance sheet vehicles, money market funds, and investment banks that operate outside of the system—proliferated, performing bank-like functions albeit with little or no regulation. In fact, in this financial crisis, we faced modern day equivalent runs on most of the shadow banking sector.

One might argue that the government is not capable of effective regulation and makes matters so much worse that it would be better to accept systemic risk and deregulate. But the legislative response to the Great Depression and its success would suggest otherwise.

And in terms of the government’s latest financial reform, the Dodd-Frank Act is clearly well intended by focusing regulation for the first time on systemic risk. Moreover, the legislation plugs some obvious holes in the financial system like off-balance sheet financing, OTC derivatives, rating agencies, and mortgage underwriting, among other areas. That said, the legislation ultimately falls short in both its approach and focus.

After a recent presentation to 170 or so risk management executives on Dodd-Frank, I took a quick poll and the vast majority believed another financial crisis was going to occur within the next ten years. This should not be surprising. The legislation does not charge systemically risky firms upfront for the systemic risk imposed upon others; instead, choosing to penalize surviving firms when a crisis occurs. This creates a free rider problem which will lead to a race to the bottom. Moreover, in terms of moral hazard, the legislation leaves in place mispriced government guarantees, and, with respect to excess leverage, conditions for regulatory arbitrage persist. There is also no attempt to create a level playing field by regulating shadow banks and banks similarly

Nevertheless, while there is little doubt that regulatory failure played an important role in the crisis, the solution should not be to walk away and leave systemic risk in place. I would still take Dodd-Frank over the current system or, more extreme, a world with zero financial regulation and frequent financial panics. But we still have plenty of wood to chop on the regulatory front. This is just the middle innings of a very long game ahead.

Matthew Richardson is a professor of finance at NYU Stern School of Business.

[July 4, 2010] Steve Keen’s Scary Minsky Model

I had the pleasure of finally meeting Steve Keen (he and his wife Melina are in New York) and it turns out he is adventuresome eater as well as thinker (he ordered maguro and natto even though I warned him, although I must say this restaurant’s version was actually gaijin friendly).

Steve told me about his presentation at a recent Minsky conference in Boston, and reader Don B had separately just e-mailed me about it. The entire talk is worth reading, and I thought I’d extract a few key parts.

Keen, following Minsky, looks aggregate demand as GDP plus the change in private debt.

Growth in debt contributed to this definition of aggregate demand in the US to a greater degree in expansion period through 2008 than in the runup to the Great Depression:

His comments thus far:

Firstly, the contribution to demand from rising private debt was far greater during the recent boom than during the Roaring Twenties—accounting for over 22% of aggregate demand versus a mere 8.7% in 1928. Secondly, the fall-off in debt-financed demand since the date of Peak Debt has been far sharper now than in the 1930s: in the 2 1/2 years since it began, we have gone from a positive 22% contribution to negative 20%; the comparable figure in 1931 (the equivalent date back then) was minus 12%.5 Thirdly, the rate of decline in debt-financed demand shows no signs of abating: deleveraging appears unlikely to stabilize any time soon.

Finally, the addition of government debt to the picture emphasizes the crucial role that fiscal policy has played in attenuating the decline in private sector demand (reducing the net impact of changing debt to minus 8%), and the speed with which the Government reacted to this crisis, compared to the 1930s. But even with the Government’s contribution, we are still on a similar trajectory to the Great Depression.

What we haven’t yet experienced—at least in a sustained manner—is deflation. That, combined with the enormous fiscal stimulus, may explain why unemployment has stabilized to some degree now despite sustained private sector deleveraging, whereas it rose consistently in the 1930s….

Whether this success can continue is now a moot point: the most recent inflation data suggests that the success of “the logic of the printing press” may be short-lived. The stubborn failure of the “V-shaped recovery” to display itself also reiterates the message of Figure 7: there has not been a sustained recovery in economic growth and unemployment since 1970 without an increase in private debt relative to GDP. For that unlikely revival to occur today, the economy would need to take a productive turn for the better at a time that its debt burden is the greatest it has ever been..

Debt-financed growth is also highly unlikely, since the transference of the bubble from one asset class to another that has been the by-product of the Fed’s too-successful rescues in the past means that all private sectors are now debt-saturated: there is no-one in the private sector left to lend to.

Yves here. Modern monetary theory types will point out that a government with a sovereign currency does not need to borrow to finance its activities, but you can eyeball Keen’s chart and see that private debt to GDP is higher even now than right before the onset of the Depression. Perilous little deleveraging has occurred.

The balance of Keen’s paper describes his Minsky model, which includes Ponzi finance (as in it simulates speculation on asset prices), which makes it unstable once certain debt levels are reached, just as Minsky predicted (and the breakdown level is similar to ones observed empirically).

There is intriguing material in there: comparisons, both in the model and empirically, contrasting a US response to the crisis (rescuing banks) versus Australia’s (shoring up households). And here is one finding:

The final debt-driven collapse, in which both wages and profitability plunge, gives the lie to the neoclassical perception that crises are caused by wages being too high, and the solution to the crisis is to reduce wages.

What their blinkered ignorance of the role of the finance sector obscures is that the essential class conflict in financial capitalism is not between workers and capitalists, but between financial and industrial capital. The rising level of debt directly leads to a falling worker share of GDP, while leaving industrial capital’s share unaffected until the final collapse drives it too into oblivion.

More bracing stuff from Keen here.

  • Richard Kline says:

    July 4, 2010 at 4:13 am

    I agree with every contention cited here from Steve Keen’s remarks. (And given my cantankerous track record, I’m amazed that I find nothing to dispute, hey!)

    But I will add an observation furthering those points, which his last chart here on ‘US debt by sector’ presents explicitly. Government and business debt have fluctuated widely through the 20th century for context-specific reasons. Household and financial system debt, by contrast, have moved in a fairly narrow band for that same duration—until 1990. From that point in time, household and financial system debt have both soared FAR above any norms for that duration. (And I expect for any norms of the 19th century as well, though I don’t have numbers in front of me on that.) And it shoudl be further noted that soaring household debt is simply a function of soaring financialy system debt since individuals were loaned that money _by the financial system_ which historically would have been much less ready to give households the dough.

    The financial system went China Syndrome nutjob burn-through from the S & L crash, and the response to that of the public authorities. We can call this the ‘Full FED Ahead’ Era should we care to. It had two key rules: Give the financials all the credit they could possibly want and remove any and all rules they might conceivably not want. We are bolloxed by they inestimably cancerous blow-up of the financial system relative to all other parts of society over the last twenty years, at levels never seen historically in our society, that is the plain conclusion. And this did not happen by accident: we did it to ourselves. More accurately, our government leadership did it to the rest of us by competely abdicating regulation and governance to the self-interested malefactors of great wealth, who went out and ate themselves to death. Or rather to TBTF Zombiehood, because though the financial system has died, it hasn’t gone away, but just sits on top of the credit system driving all of the oxygen out of the pond through its own rot.

    We will have no recovery until we dismember and burn the zombies of the financial system: it is that simple. And we haven’t even begun, which is why there is no deleveraging to speak of. I won’t raise the issue of what happens with artificial government induced systemic debt goes sideways on us, the endless power to print more of it notwithstanding. But just look at the history of sector balances presented here, and the story writes itself. Too bad it won’t right itself; for that, we need justice.

  •  Richard Kline says:

    July 4, 2010 at 4:15 am

    ” . . . by competely abdicating governance [&etc.] . . .”

  •  reskeptical says:

    July 4, 2010 at 4:56 am

    Wow– US debt by sector graph is incredible. Review and publish widely.

    Richard- in this graph financial sector debt looks to have grown exponentially from 1950. Houshold and business debt seems almost linear– albeit with a blow up in Household shortly before the turn of the century (as you point out). Interestingly this coincides with financial debt overtaking household debt etc. but the fix (wrt. finance) seems to have been in long before…

    When was Greenspan’s tenure again? Hmmm…

  •  michel says:

    July 4, 2010 at 5:07 am

    The paper keeps referring to “capitalists”. Does anyone know who these people are? Or the “workers” either who keep being referred to?

  •  Jamisia says:

    July 4, 2010 at 5:35 am

    The obvious thing here is to suggest implementation of a Job Guarantee, not necessarily the printing presses.
    Keen’s findings remind me, by the way, of an article by the late Wynne Godley, titled “Seven Unsustainable Processes” ( If you consider that MMT, I’m not sure MMT types would find much to disagree about in models by Keen.

  •  Toby says:
  • July 4, 2010 at 6:09 am

  • “gives the lie to the neoclassical perception that crises are caused by wages being too high, and the solution to the crisis is to reduce wages.”

  • A very important and potent rebuttal.

  • I suppose the orthodox view would be that supply and demand intersections determine price; labour needs to be demanded/not demanded by employers, and workers supply/not supply their labour. The balance of these two inputs determine wage, not policy.

  • However, as we all know, workers have to eat, live and raise families, so the above mechanical, ‘value free’ analysis cannot reflect the full picture. That wages have been kept so low for so long during high productivity and GDP growth is surely another blow to orthodox theory. In simple terms the data says clearly that the employer tends to have the power, especially when govt. is on the employer’s side. ‘Free’ market, anyone?

  • That said, I’m still sure technological unemployment has played a pivotal role in keeping wages low. There is less and less need for lots of labour to produce lots of stuff. For consumption to stay high while wages stay low, therefore, debt has to increase (aside from the fact that money is created as debt). It’s a no brainer, surely…

  •  michel says:

    July 4, 2010 at 6:39 am

    Public sector employment [in the UK] decreased by 7,000 (seasonally adjusted) in the first quarter of 2010 to 6.090 million.

    Are these 6 million people “workers”?

  •  joebhed says:

    July 4, 2010 at 7:45 am

    “”Yves here. Modern monetary theory types will point out that a government with a sovereign currency does not need to borrow to finance its activities, but……”

    uummmmm… the disconnect that I am not seeing addressed in this discussion is the truism that a sovereign national monetary system is capable of creating all the circulating medium without any borrowing – that none of the national circulating medium must come into existence as a debt.

    Yet the MMTers are limited to showing that the government’s role, in its sectoral analysis approach, can be ‘financed’ by debt-free money – and that is only if we would remove the self-imposed constraint of something called the private, debt-money system of fractional-reserve banking.

    Truth being that under a Constitutional government-issue, debt-free money system, as proposed by the American Monetary Institute, and also by MOST practicing economists some 70 years ago, we are capable of providing into the national economy ALL of the circulating medium required to meet our national goals of economic stability and full-employment. And doing so without creating any debts at time of issue.
    After which, of course, it would be lent out to its highest and best use.

    It’s the debt-money system that’s insolvent.
    What we need is a new money system.

  •  gigi says:

    July 4, 2010 at 8:22 am

    Wonderful paper from Steve Keen. I can only sit and applaud.

  •  Jim Haygood says:

    July 4, 2010 at 8:34 am

    ‘The addition of government debt to the picture emphasizes the crucial role that fiscal policy has played in attenuating the decline in private sector demand (reducing the net impact of changing debt to minus 8%).’

    I’m not sure why the aggregate demand chart concentrates only on the change in private debt. Although there may be some difference in efficiency, rising government debt adds to aggregate demand too, as the quoted statement notes.

    Deflationists tend to be dogmatic in claiming that inflation can’t happen without private-sector lending expansion. But there are counterexamples: does anyone claim that private sector debt was expanding (in real terms) during Zimbabwe’s recent hyperinflation? Pure printing-press inflation does not require ANY private sector debt.

    Unless I’m badly mistaken, my buddy Weimar Ben Bernanke is preparing a pre-emptive, shock ‘n awe ‘QE II’ even as we speak. An apocalyptic showdown looms, in which the deflationists (I believe) will be vanquished by a remorseless wall of fiat currency.

    GO, BENNY, GO!

  •  /L says:

    July 4, 2010 at 8:37 am

    What is amazing is how little the economic “science” knows for sure, there are competing alternatives on most things. They don’t even have a serious comprehensive knowledge about how money works. There are consensus agreements among established “scientists” on several things but no true knowledge. Despite this they repeatedly serve what their masters want to here. Could this be the core problem of this “scientific” branch, that they primarily are not scientist but their masters servants?

    They intimidate people

  •  Cindy6 says:

    July 4, 2010 at 9:10 am

    Intriguing work!

    Which leads to the question, what’s the point of having debt in the system at all? It seems to do nothing except to exaggerate natural economic swings.

    Ponzi good times need to be paid, eventually, painfully.

  •  Siggy says:

    July 4, 2010 at 9:59 am

    Thanks for the Keen paper.

    Very interesting analysis and point of view.

  •  MDR says:

    July 4, 2010 at 10:45 am

    Deflation is at work throughout our economy. Take rent for example; major deflation in prices. Take many goods; prices are being cut.

    However, I believe the key element holding back significant deflation is THE PRICE OF OIL. Have you noticed how stubbornly it holds up? Anyone suspect collusion with key Arab players? Oil is a primary price input for a vast majority of our economy. If it drops, prices will plummet. I believe, the US Government and others are attempting to hold the price up through output regulation; primarily by the Saudis.

  •  Lineman says:

    July 4, 2010 at 10:56 am

    Thanks for the excellent post.

    Back of the napkin, in the Great Depression, the US GDP did not begin to recover until combined private debt decended to about 40% of GDP. That would be 25% Household, 12% Business and 3% Finance. This is a very scary number indeed since it implies the current private US debt levels could plummet much further before a point of sustainable recovery is reached.

  •  stf says:

    July 4, 2010 at 10:57 am


    I’m puzzled by your MMT comment there. I fail to see anything in Keen’s analysis inconsistent with MMT. It makes perfect sense to me that the policy response in the current crisis has reduced private deleveraging compared to the 1930s. This is precisely why MMT’ers advocate, in ADDITION to a strong policy response, substantial reform of the financial sector (there’s literally dozens of research publications and blogs on this topic by MMT’ers in the past few years). Steve (and most of his “followers”) repeatedly fails to recognize this part of MMT, even though I and others have reminded him many times (several MMT’ers were either colleagues or students of Minsky, in fact).

  •  purple says:

    July 4, 2010 at 11:19 am

    Family lore says that my grandfather, a union construction worker, bought his first car with cash after WW2. How many construction workers can do that now ? Of course, it is common to buy with cash in China. Point being, debt financing in US households has most definitely contributed to a feeling of false prosperity.

  •  Tom Hickey says:

    July 4, 2010 at 11:35 am

    Modern monetary theory types will point out that a government with a sovereign currency does not need to borrow to finance its activities, but you can eyeball Keen’s chart and see that private debt to GDP is higher even now than right before the onset of the Depression. Perilous little deleveraging has occurred.

    All MMT’ers are in agreement with Minsky. Randy Wray was a student of Minsky, for example.

    One of MMT’s main contentions is that if government does not make up for the public’s increasing desire to save/delever, then absent an offset by exports (unlikely for the US and mathematically impossible for all countries simultaneously) deflation will result.

    This is the reason that MMT is so opposed to fiscal austerity to “solve” the current problem. It will greatly exacerbate it instead. The world is not past the threat of global depression by any means, and the best case scenario to be hoped for under current policies is Japanification and a lost decade or two. This applies not just to the US. European policymakers are even more deluded in their zeal for austerity.

    And as others have observed a monetarily sovereign government that is the sole provider of a nonconvertible floating rate currency of issue is not financially required to issue bonds at all. The CB (Fed in US) can just pay a support rate on reserves if it still want to control the overnight rate (FFR), or it can set the overnight rate at zero, like the Bank of Canada does.

  •  stf says:

    July 4, 2010 at 11:45 am

    “All MMT’ers are in agreement with Minsky. Randy Wray was a student of Minsky, for example.”

    Exactly my point at 10:57am above, too. I don’t see the point of Yves including that MMT statement, unless she’s repeating something Steve said to her–actually sounds like the sort of mis-characterizations of MMT he somehow manages to make regularly despite the number of times we’ve all corrected him.

  •  Ronald says:

    July 4, 2010 at 11:55 am

    ” there has not been a sustained recovery in economic growth and unemployment since 1970 without an increase in private debt relative to GDP.”

    The 70’s oil shock continues to rock the foundation of an economy based around cheap available oil. Road building was the industry of choice for the current administrations stimulus spending hoping that new paved roads would somehow
    continue the urban build out with another round of shopping centers,schools, fire houses,warehouses and of course houses but its not happening a clear sign that the post war economic era has run out of cheap gas.

  •  Hugh says:

    July 4, 2010 at 12:16 pm

    “class conflict in financial capitalism is not between workers and capitalists, but between financial
    and industrial capital”

    I do not agree with this. Certainly, we have seen Wall Street beat up Main Street, but the key remains 30 years of flat wages and an enormous maldistribution of wealth upward, creating the paper economy which established and expressed the dominance of Wall Street (the investment class) over Main Street (workers).

  •  anon says:

    July 4, 2010 at 1:06 pm

    Keen’s brand of circuitism and MMT are like ships passing in the night. They should be complementary. They just need to listen to each other – in both directions.

  •  Ronald says:

    July 4, 2010 at 1:14 pm

    “The reality is that finance takes the form of debt – and gambling. Its gains therefore were made from the economy at large. They were extractive, not productive. Wealth at the rentier top of the economic pyramid shrank the base below.”

    Good point!

  •  michel says:

    July 4, 2010 at 1:24 pm

    “gives the lie to the neoclassical perception that crises are caused by wages being too high, and the solution to the crisis is to reduce wages.”

    Have you ever heard anyone say this? It has been argued in the UK that the problem with current policy is that it pays people not to work, but stay on welfare of various sorts, because they are better off that way. It has been argued that if you are in state housing, which you lose if you move, that you will not then move in search of work. Or even if guaranteed work in the new location.

    But the idea that the current crisis is caused by or exacerbated by ‘too high’ wages? Never heard it said.

  •  BlackBox says:

    July 4, 2010 at 1:39 pm

    Great paper by Keen. One thing it clarifies is why the financial sector has grown so large in recent years. It is precisely because debt, in all its forms, has expanded so much. The financial sector feeds on debt as its raw material. Debt has to be sold, resold, rolled over, structured and restructured. Portfolios must be managed, spreads must be captured, and mismatched maturities must be brought together, etc, etc. The more debt, the more work (and pay) for financiers.

    From a Minsky point of view, it is no surprise that the financial sector grew along with the debt until, on the eve of the crisis, it absorbed a substantial portion of all the profits in the system.

    For the future then, whether we like it or not, a large financial system will be with us for as long as there is substantial debt to manage. So unless or until there is a collapse, there will be plenty of work to do for Goldman Sachs and all the others.

  •  alex says:

    July 4, 2010 at 2:40 pm


    Great to see you getting together with Steve Keen. The two of you have been some of my favorite sources of information on the Great Meltdown, from complimentary POV’s (business/politics perspective vs. economist’s perspective).

    I’ve long found Steve’s debt/GDP graphs scary, and I’m glad you’re introducing them to more of your readers. He’s convinced me that serious private sector deleveraging is indeed necessary for a real recovery, and hence the Fed’s “hair of the dog that bit you” approach to our private sector debt hangover is misguided. Not to say the Fed should suddenly jack up interest rates, but ZIRP is perhaps going too far. So far its main effect is to enrich banks that profit off the interest rate spread.

    It’s also an important reason why I think the bank rescues were misguided. Better to take insolvent institutions into receivership and let the bond holders take haircuts. That’s deleveraging.

    Of course, by an astounding coincidence, both ZIRP and the bailouts have the banks as their main beneficiaries.

    Question: do you or Steve Keen have any suggestions how private sector deleveraging could be accelerated? (preferably without causing a bigger meltdown in the process).

    P.S. What’s so adventuresome about maguro? I thought it was just tuna.

  •  craazyman says:

    July 4, 2010 at 3:51 pm

    Rob Parenteau the other day had a post that suggested the business sector was hoarding cash and looting through exorbitant executive pay (my rough recollection of what he said).

    Just as government debt cannot be compared to household debt, neither can corporate debt. Corporate debt is offset on the balance sheet against “shareholders equity” which is created from stock sales and retained earnings. Households have nothing similar — “wealth” to a point, but that is all tied to market value and its vagaries.

    Even though business debt, in the charts above, is rising. That does not imply what the ratio of debt to capitalization is, which is a more relevant financial measure of corporate leverage. Moreover, it would seem, visually speaking, that business debt could rise if more businesses were created globally as well as if business with strong balance sheets borrowed. I reall all the time about how strong many corporate balance sheets are.

    It may be that corporate borrowing could act as a reservoir for private savings to a degree to juice the economy forward.

    But corporations don’t now see — through failure of imagination or through lack of confidence in the larger economic system — the chance for profitable deployment of the capital raised through debt offerings, in a way that would also raise retained earnings.

    We’re in an imagination lock right now. There are plenty of poor people who would like to work and prosper and buy things, but they and their potential employers are frozen in an imagination mind chain lock.

  •  Darrell Balmer says:

    July 4, 2010 at 4:34 pm

    Viewing the great recession as arising because of to much debt misses the other side of the coin, the savings side. Borrowing has to equal savings. Consumer wealth inequality partly arising from tax cuts for which government had to replace with borrowing, the ability of the financial system to magnify savings, and trading partner mercantile policies contributed a savings side cause to the great recession. The following provides a simplified macroeconomic model of how wealth and income inequality might have increased and contributed to causing the great recession.

    Macroeconomic analysis starts with four cohorts, consumers (C), businesses (B), government (G), and trading partners (F). To understand the following dynamic, consumers will be divided into two cohorts and businesses will be divided into two cohorts.

    The two business cohorts are finance industry (Bf) and non-finance industry (Bn). Understanding the finance industry (Bf) cohort is critical to the following model. The finance industry (Bf) cohort is a conduit for matching savings and borrowing and a creator of an increasing level of funds for borrowing. Money is created by the Federal Reserve. Fractional banking magnifies the funds created. If bank reserve requirements are 10%, the fractional system provides an increase of $10 in loans for every $1 created by the Federal Reserve. The finance industry (Bf) cohort magnified Federal Reserve money creation even further by the creation of shadow banking units, some of which had reserves of about 3% creating $30+ dollars for every dollar of reserves.

    For the consumer cohorts, assume a correlation between income level and savings. Stated simply assume low income consumers to be net borrowers and high income consumers to be net savers. Assume some percentage of consumers such as the lowest 90% in income borrow on net an amount equal to the net savings of the highest income 10%. Whether 90% is the right number is not critical to the following discussion. The consumers cohorts are consumer borrowers (C90%) and consumer savers (C10%).

    Some observations about the 2000s leading up to the great recession. Government (G) net borrowing and trading partners (F) net savings in the US were about equal. The finance industry (Bf) accounted for more GDP and profit growth in the 2000s than non-finance industry (Bn). Consumer savings were low and are assumed to be zero for the following discussion. Consumer income and wealth inequality did increase.

    Here is a simplified description of what took place.

    * Government (G) lowered taxes benefiting primarily the consumer savers (C10%) cohort. This increased the level of savings searching for investment.
    * Consumer borrowers (C90%) wanted to buy much of our trading partners (F) products and services.
    * For consumer borrowers (C90%) to buy these products and services, savings had to be made available to them.
    * As we well know now, the borrowing of consumer borrowers (C90%) greatly exceeded their ability to pay from current and expected income.
    * Savings was made available to consumer borrowers (C90%) through the finance industry (Bf) based on expected increases in new and existing home values used as collateral.
    * Trading partners (F) on net ran mercantile policies. The US trade deficit (and current account deficit) was financed by trading partners lending to us. In other words our trading partners on net had dollars they wanted to save instead of spend.

    * Savings flowed from consumer savers (C10%) and trading partners (F).
    * The finance industry (Bf) was a conduit magnifying consumer savers (C10%) savings. Since the finance industry (Bf) is primarily owned by consumers savers (C10%), it can best be viewed as an extension of consumer savers (C10%). The growth of the finance industry (Bf) primarily benefited consumer savers (C10%) cohort contributing to wealth and income inequality.
    * High finance industry (Bf) wages and bonuses went primarily to people who were in the consumer savers (C10%) cohort further contributing to wealth and income inequality.
    * Non-finance businesses (Bn) were not major borrowers or savers.
    * The flow of savings was to consumer borrowers (C90%) and government (G).
    * The source of savings was trading partners (F) and consumer savers (10%).
    * Trading partners (F) savings went primarily to fund government (G) debt.
    * Consumer savers (C10%) (including finance industry (Bf) created money) went primarily to consumer borrowers (C90%).
    * When home values ceased to provide collateral for consumer borrower (C90%) debt, consumer savers (C10%) and the finance industry (Bf) suffered the losses. The losses for consumer savers (C10%) were increased by the fact that this cohort was the primary owner of finance industry (Bf) equity and bonds.

    What was the role of government deficits in this dynamic. If government (G) had not run deficits, consumer savers (C10%) would have had less savings and trading partners (F) would have had to make up the savings difference (or sell less) taking on some of the consumer borrowers (C90%) credit risk. Trading partners (F) might have been less generous with credit terms. Even if the great recession still happened the risk would have been spread more broadly between beneficiaries of the boom, the consumer savers (C10%) and trading partners (F). Interestingly trading partners (F) savings placed in government (G) borrowing avoided the losses that consumer savers (C10%) suffered as result of placing savings through and having ownership interest in the finance industry (Bf).

  •  Gerold K. B. Weber says:

    July 4, 2010 at 5:01 pm

    Great post and discussion.

    The best understanding of the (re)current crises seem to lie in a synthesis of a Minsky-enriched “sectoral balances approach” (Keen et al.) with Marxist explanations (see e.g. Foster’s and Magdoff’s “Great Financial Crisis”, or David Harvey).

    As Marx and class conflicts are tabooed in US mainstream discourse, a thorough discussion of such a synthesis might currently have no chance to convince mainstream policy makers and their economic advisers, and in fact does currently not happen.

    This might also be the reason why some major contributors (Marshall Auerback, Rob Parenteau) are tactically framing the GFC as a conflict between industrial capitalists and finance capitalist.

    I hope a more honest way forward will be found.

    One of the most relevant next steps might be to show that GLOBALLY aggregate demand cannot be sustained under (near) full employment without ever increasing levels of household and/or government debt.

    If this holds true, THE major imbalance has been found. It then has to be collectively addressed, and solved.

  •  SteveB says:

    July 4, 2010 at 7:17 pm

    Official Personal Consumption Expenditures, and Retail Sales, started to increase again in 2009. Thus they seem to track plain GDP, not what Keen calls Aggregate Demand, (GDP plus change in debt). Although Keen’s ideas seem reasonable, the data does not seem to support it.

  •  Obvious says:

    July 4, 2010 at 7:45 pm

    US private sector economic activity is constrained by the elephant in the room – gargantuan US federal income tax increases now less than six months away, plus the incalculable (though inarguably huge) costs of new healthcare legislation. Just as Europe wakes up to the realisation it can no longer subsidise lifestyles unmoored from societal productivity, the U.S. is moving to the same high tax/high (public) benefit model Europe is abandoning as unaffordable. All the Krugman-type arguments about the need to maintain governmental stimulus (conveniently) overlook the fact that the US, the UK et al are already broke/running gargantuan deficits, with trillions of dollars of committed (soon to be reneged-on) benefits. In the 1930’s, when austerity was prematurely imposed, the US had a clean balance sheet. That is no longer the case. Trichet knows the score; Obama and Bernanke do not (or don’t care). What is coming, will be awful, but it will be even worse if even more societal debt is laid on to avoid the inevitable.

  •  Obvious says:

    July 5, 2010 at 7:30 am

    Hugh: your basic thesis was more simply stated in the 19th century: “From each according to his abilities, to each according to his needs”. You are certainly free to spout this kind of class warfare gibberish, just don’t expect me to take it seriously or treat it as anything other than the neo-Marxist claptrap that it is.


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