Abstract
I suppose I have been asked to review this book as I have written various papers, including two for Accounting History (Barnes, 2007, 2011) on Minsky’s financial instability hypothesis (“FIH”), the subject of this book, and the financial crises of 1866, 1987, and 2007–2009. My interest there was the role of accounting and financial information in the “boom” and “bust” not only as to how it contributes to the former by helping to overstate financial results but also to the latter by causing them to be understated. While the FIH was particularly appealing at recognizing the behavior (catching the eye of pundits and commentators), it was not so good at forecasting or predicting the “Minsky moment” when upturn changed to downturn. In other words, its descriptive appeal was not matched by its predictive ability. In fact, having just written about it, I was just as surprised as others when the 2007 crash came.
Just to remind the reader: in financial economics, a liquidity crisis refers to the ease with which market participants may buy or sell assets without affecting their price. The 2007 crisis began in the US when certain mortgage lenders failed, which was brought about by the new financial instruments involved, notably the securitization of their subprime lending through subprime-related securities and derivatives. The crisis quickly spread across the United States, to the United Kingdom (the Northern Rock, a large bank that depended on inter-bank borrowing, which also found itself unable to borrow and without funds followed by others), and Iceland, which suffered the largest banking collapse by any country in economic history, and elsewhere.
The FIH relates to how economic units’ expectations may move from optimistic to pessimistic causing an economy to move from a robust to a fragile state, a cycle involving irrationality, a notion quite contrary to that of equilibrium and concepts of arbitrage and the efficient markets hypothesis (EMH), the latter particularly, given the miss-pricing of risk in securitization. Minsky, once a student of Keynes, called the FIH an “interpretation” (Minsky, 1982) of Keynes’ (1936) General Theory of Employment Interest and Money. But the “General Theory” was written at least 20 years before Minsky began to write about liquidity crises and how new developments in financial instruments could result in asset price rises and increases in funding liquidity giving rise to the FIH. The important question posed by Jefferis is, therefore, how could Minsky’s FIH based on Keynes’ General Theory 30–40 years earlier fits the 2007 financial crisis brought about by securitization? This is particularly the case, in Jefferis’s view, as, while the FIH recognizes uncertainty, it has no theory of, and therefore pricing of, risk. Hence, Jefferis’s reference to “dialectics” and the “historicity” of financial crises and the assumption that they are “variations on a theme.”
It is here we see the relevance of this book. A theory of crises (as the FIH is) should not only provide an explanation of crises but contribute not only to their prediction and avoidance but also to their elimination. As Jefferis shows (and at the time of writing, commentators are warning of a crisis similar in nature to 2007, arising from an expansion of liquidity), there is little evidence of the latter. In fact, since 2007, there has been little agreement on what should be done.
It should not be thought that this is merely a critique of the FIH and contemporary equilibrium-based financial economics. Rather, the later chapters represent a reinterpretation and reformulation of the FIH in an effort to examine the mismatch between theory and actuality (“the abiding driver of analysis” of the book) and continuing problems within the US mortgage market. While the extent to which this has been successful together with Jefferis’s proposed reforms is for economists and regulators to decide, this book (particularly the early chapters) raises many important issues on the historicity of the FIH and EMH for accounting and financial history researchers.