Why Minsky still matters
Lars Syll
Perhaps the foremost financial crisis theorist of our time, Hyman Minsky, had as his central idea that crises are endogenous (system-internal) phenomena where stability creates instability and reduces safety margins for financial transactions with excessively high leverage effects. During the upswing phase of financial bubbles, safety margins shrink, and even the smallest setback can lead to expectations not being met, forcing companies and investors to revise their plans to meet their cash flow commitments. The result may be that assets have to be sold, contributing to a debt deflation process with increasingly larger real debt burdens and problems resolving liquidity issues through asset disposals.
According to Minsky, these were inevitable processes. “Stability creates instability” even without euphoria and excessive optimism. During the upswing phase, banks’ lending practices are confirmed and even validate riskier projects. In accordance with the cascade of information theory, we encounter a logic where what was initially perceived as risky ends up being experienced as completely risk-free. The banks become more and more confident.
Securitisation has meant that traditional credit ratings have been replaced by ratings performed by rating agencies without first-hand knowledge of the borrowers. This is based on a kind of stochastic assessment where, instead of relying on the credit history of each individual borrower, the borrowers are viewed as random realisations of a “representative” borrower with risks that follow a normal distribution curve with a given mean and variation. However, if real borrowers do not exhibit the degree of homogeneity that such a statistical approach is based on, the shortcomings of the model become apparent. When the risk turns out to be “fat-tailed”, the intention to reduce and distribute the risks is turned on its head. The problem is that this is not really evident until the crisis is in full bloom and the “representative” borrower is hanging by a thread. Assets that banks have tried to move off-balance sheets through securitisation reappear when the institutions they have created off-balance sheets are forced to seek help to solve acute liquidity problems.
One of the fundamental reasons behind recent financial crises is that those who take the risks are no longer responsible for evaluating borrowers’ ability to bear their costs. The instruments that are said by the financial market’s own representatives to be created to distribute risk optimally among different actors cannot fulfil their task when there is no credible mechanism for assessing risks. Not even in capitalism’s flagship, the financial markets, can genuine economic uncertainty be reduced to manageable stochastic risks (stochastic processes are like the ones we have when we flip a coin and we know with certainty that the outcomes are either heads or tails and where randomness means that in repeated coin flips we have an equal chance of getting heads as tails). If securities and other assets are priced based on risks estimated with assumptions that apply to stochastic normal distribution models, these prices can never be better than the model assumptions they are based on. In normal times, they may provide decent approximations, but when bubbles grow and the future definitely does not look like history (in statistical terms, economies are not ergodic systems, where processes remain unchanged over time), the result is spelt crisis.
Crises stem from a financial system that systematically undervalues risks and overvalues creditworthiness. The financial instability that Minsky claimed permeates financial markets cannot be completely eliminated. However, we can ensure the implementation of regulations and institutions that minimise the damage.
Conventional theory struggles to explain financial crises. Often, the explanation is that it results from reckless speculation by irrational “noise traders.” In reality, the cause is that we do not have perfect information about the future, and it is precisely future expectations that drive the financial market. Speculation is about trying to anticipate how these future expectations will manifest themselves in the market. This is difficult to do — market psychology is hard to grasp — and often leads to rapid market swings and herd-like behaviour, where expectations of what other speculators expect play a greater role than economic fundamentals. Crises are fundamentally endogenous, not exogenous (information failures, irrationality, etc.). Financial crises are not anomalies but rather they are a highly possible and expected part of a genuinely uncertain economic world.
The main lesson that financial crisis theory and historical experience teach us is that recurring financial crises are part of the essence of our economic system. They are not simply a series of coincidences and misjudgements. They are a consequence of the deeper underlying and long-term instabilities that characterise the financial system itself and are a source of economic instability and crises.
So, what can we do to minimise the risk of future crises and prevent the economy from completely grinding to a halt? The neoliberal era has reached its end. What is needed now is enlightened action based on a relevant and realistic economic theory of the kind that Keynes and Minsky represent.
As long as we have an economy with unregulated financial markets, we will also be subject to periodically recurring crises. That does not mean that we should just sit with our arms crossed and wait for a storm to pass. A Keynesian tax on the financial market, stricter regulations, and increased transparency can actively contribute to reducing the risks of costly financial system crises in the long run. However, if we reflexively refuse to see the extent of the problems, we will once again be powerless when the next crisis looms.
One of the fundamental misconceptions in today’s crisis discussion is that one does not distinguish between debt and debt. Even though at the macro level it is necessary that debts and assets balance each other out, it is not insignificant who has the assets and who has the debts.
As a young research stipendiary in the U.S. more than forty years ago, yours truly had the great pleasure and privilege of having Hyman Minsky as a teacher.
He was a great inspiration at the time. He still is.
Source: Real World Econ Rev, 9 Mar 2026 https://rwer.wordpress.com/2026/03/09/why-minsky-still-matters/
Editorial comments
Lars Syll correctly criticises the assessments of borrowers by ratings agencies and emphasises the necessity to enforce stricter regulations. However these agencies have become a central source of systemic corruption (e.g. The Big Short), and we gather that the main driver is simply, taking bigger risks produces bigger profits -until they don’t. In the light of Steve Keen’s modelling of Minsky’s instability hypothesis, it is far from certain that Lars’ recommendations about reforming credit rating practices would be sufficient to stabilise the system.
The reality of the situation is that the credit ratings agencies have been captured by the finance industry – a longstanding and persistent problem – and this flaw should be addressed in framing any agency reforms. Also there is widespread collusion and corruption among the agencies, and sensible economists have learnt to ignore their procrastinations. It is therefore sad and unfortunate that governments continue to allow themselves to be influenced by the same agencies. A thorough expose on international rating agencies is long overdue, and perhaps could be accomplished by independent journalists investigating their purpose, processes and operations.
Moreover, at this time, opaque private credit and private equity markets — the size of which have ballooned over the past few years — appear to be undergoing a slow motion crisis with all the hallmarks of a collapsing Ponzi-financing scheme. Unknown but elevated levels of risky lending by both banks and non-bank financial institutions (such as insurance companies and pension funds) are seeing the light of day, as such funds close to redemptions and investors are left holding the bag. Whether this develops into a major credit event is uncertain but is currently creating major waves of anxiety in financial systems.
