Lesson+16+Credit+Crisis - Lesson 16 How Did We Get Here...

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Lesson 16-- How Did We Get Here? This was originally lesson 21 on the syllabus Ip Chapter14 The Shadow Banking System and Hyman Minsky’s Economic Journey , Paul McCulley, PIMCO's Global Central Bank Focus, May 2009 http://www.pimco.com/LeftNav /Featured+Market+Commentary/FF/2009/Global+Central+Bank+Focus+May+2009+Shadow+Banking Minsky+McCulley. htm Six Fingers of Blame in the Mortgage Mess , Op-Ed NYT Sept 30, 2007 http://www.nytimes.com/2007/09/30/business/30view.html?_r=1&scp =7&sq=Alan%20Blinder&st=cse
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The Financial Instability Hypothesis -- “Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified.” Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit Speculative finance units are units that can meet their payment commitments on ‘income account’ on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to ‘roll over’ their liabilities (e.g., issue new debt to meet commitments on maturing debt).… Ponzi units , the cash flows from operations are not sufficient to fulfill either the repayment of principal or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes.…
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The Financial Instability Hypothesis It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and -containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system .
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McCulley’s Application of Minsky-- The U.S.
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