22 Manias,Panics,and Crashes Ricostruzione Industriale (IRI)in Italy (in 1933).The Italian literature calls the process the 'salvage'of banks and companies;the British in 1974-1975 referred to saving the fringe banks as a'lifeboat'operation. The questions related to a domestic lender of last resort are the focus of Chapter 11-primarily whether there should be a lender of last resort, who this lender should be and how it should operate.A key topic is 'moral hazard'-if investors are confident that they will be bailed out' by a lender of last resort,their self-reliance may be weakened.But on the other hand,the priority may be to stop the Danic,to 'save the system today'despite the adverse effects on the incentives of investors.If there is a lender of last resort,however,whom should it save?Insiders?Outsiders and insiders?Only the solvent,if illiquid?But solvency depends on the extent and duration of the panic.These are political questions,and they are raised in particular when it becomes necessary to legislate to increase the capital of the Federal Deposit Insurance Corporation(FDIC)or the Federal Savings and Loan Insurance Corporation(FSLIC)when one or the other runs out of funds to lend to banks in trouble in time of acute stress The issue was particularly acute in the 1990s in Japan,where the collapse of the Nikkei stock bubble in 1990 uncovered all sorts of bad real estate loans by banks,credit unions,and other financial houses,confronting the government with the neuralgic question of how much of a burden to put on the taxpayer.Particularly troubling was the catatonic state of government in Japan in the 1990s,slow to decide how to meet the crisis and slower to act. The penultimate chapter centers on the need for an international lender of last resort to provide global monetary stability even though there is no responsible government or agency of government with the de jure responsibility for providing this public good.U.S.government support for Mexico,first in 1982 and again in 1994 was justifed on the grounds that countries of the North American Free Trade Agreement (NAFTA)should stick together and that assistance to Mexico would dampen or neutralize the contagion effect and prevent a collapse of lending to the 'emerging market'countries of Brazil and Argentina and other developing countries.The sharp depreciation of the Thai baht in the early summer of 1997 triggered crises in nearby Asian countries in- cluding Indonesia,Malaysia,and South Korea as well as in Singapore, Hong Kong,and Taiwan. The last chapter seeks to answer two questions;the first is why there has been so much economic turmoil in the international financial econ omy in the last thirty years,and the second is whether an international
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 22 Manias, Panics, and Crashes Ricostruzione Industriale (IRI) in Italy (in 1933). The Italian literature calls the process the ‘salvage’ of banks and companies; the British in 1974–1975 referred to saving the fringe banks as a ‘lifeboat’ operation. The questions related to a domestic lender of last resort are the focus of Chapter 11—primarily whether there should be a lender of last resort, who this lender should be and how it should operate. A key topic is ‘moral hazard’—if investors are confident that they will be ‘bailed out’ by a lender of last resort, their self-reliance may be weakened. But on the other hand, the priority may be to stop the panic, to ‘save the system today’ despite the adverse effects on the incentives of investors. If there is a lender of last resort, however, whom should it save? Insiders? Outsiders and insiders? Only the solvent, if illiquid? But solvency depends on the extent and duration of the panic. These are political questions, and they are raised in particular when it becomes necessary to legislate to increase the capital of the Federal Deposit Insurance Corporation (FDIC) or the Federal Savings and Loan Insurance Corporation (FSLIC) when one or the other runs out of funds to lend to banks in trouble in time of acute stress. The issue was particularly acute in the 1990s in Japan, where the collapse of the Nikkei stock bubble in 1990 uncovered all sorts of bad real estate loans by banks, credit unions, and other financial houses, confronting the government with the neuralgic question of how much of a burden to put on the taxpayer. Particularly troubling was the catatonic state of government in Japan in the 1990s, slow to decide how to meet the crisis and slower to act. The penultimate chapter centers on the need for an international lender of last resort to provide global monetary stability even though there is no responsible government or agency of government with the de jure responsibility for providing this public good. U.S. government support for Mexico, first in 1982 and again in 1994 was justified on the grounds that countries of the North American Free Trade Agreement (NAFTA) should stick together and that assistance to Mexico would dampen or neutralize the contagion effect and prevent a collapse of lending to the ‘emerging market’ countries of Brazil and Argentina and other developing countries. The sharp depreciation of the Thai baht in the early summer of 1997 triggered crises in nearby Asian countries including Indonesia, Malaysia, and South Korea as well as in Singapore, Hong Kong, and Taiwan. The last chapter seeks to answer two questions; the first is why there has been so much economic turmoil in the international financial economy in the last thirty years, and the second is whether an international
Financial Crisis:A Hardy Perennial 23 lender of last resort would have made a difference.The International Monetary Fund was established in the 1940s to act as an international lender of last resort and to fill an institutional vacuum;the view was that financial crises in the 1920s and the 1930s would have been less severe had there been an international lender of last resort.The large number of crises in the last thirty years leads to the question of whether the presence of the IMF as a supplier of national currencies to countries with financial crises encouraged profligate national financial policies. financial arrangements need a lender of last resort to prevent the es. calation of the panics that are associated with crashes in asset prices.But the commitment that a lender is needed should be distinguished from the view that individual borrowers will bebailed out'if they become over-extended.For example,uncertainty about whether New York City would be helped.and by whom.may have proved iust right in the long run,so long as help was finally provided,and so long as there was doubt right to the end as to whether it would be.This is a neat trick:always come to the rescue,in order to prevent needless deflation,but always leave it uncertain whether rescue will arrive in time or at all,so as to in- still caution in other speculators,banks,cities,or countries.In Voltaire's Candide,the head of a general was cut off 'to encourage the others.'A sleight of hand may be necessary to 'encourage'the others(without of course,cutting off actual heads)to participate in the lender of last resort activities because the alternative is likely to have very expensive consequences for the economic system
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 23 lender of last resort would have made a difference. The International Monetary Fund was established in the 1940s to act as an international lender of last resort and to fill an institutional vacuum; the view was that financial crises in the 1920s and the 1930s would have been less severe had there been an international lender of last resort. The large number of crises in the last thirty years leads to the question of whether the presence of the IMF as a supplier of national currencies to countries with financial crises encouraged profligate national financial policies. Financial arrangements need a lender of last resort to prevent the escalation of the panics that are associated with crashes in asset prices. But the commitment that a lender is needed should be distinguished from the view that individual borrowers will be ‘bailed out’ if they become over-extended. For example, uncertainty about whether New York City would be helped, and by whom, may have proved just right in the long run, so long as help was finally provided, and so long as there was doubt right to the end as to whether it would be. This is a neat trick: always come to the rescue, in order to prevent needless deflation, but always leave it uncertain whether rescue will arrive in time or at all, so as to instill caution in other speculators, banks, cities, or countries. In Voltaire’s Candide, the head of a general was cut off ‘to encourage the others.’ A sleight of hand may be necessary to ‘encourage’ the others (without, of course, cutting off actual heads) to participate in the lender of last resort activities because the alternative is likely to have very expensive consequences for the economic system
2 Anatomy of a Typical Crisis History vs economics For historians each event is unique.In contrast economists maintain that there are patterns in the data and particular events are likely to induce similar responses.History is particular;economics is general. The business cycle is a standard feature of market economies;increases in investment in plant and equipment lead to increases in house- hold income and the rate of growth of national income.Macroeco- nomics focuses on the explanations for the cyclical variations in the rate of growth of national income relative to its long-run trend rate of growth. An economic model of a general financial crisis is presented in this chapter,while the various phases of the speculative manias that lead to crises are illustrated in the following chapters.This model of general financial crises covers the boom and the subsequent bust and centers on the episodic nature of the manias and the subsequent crises.This model differs from those that focus on the variations and the period- icity of economic expansions and contractions,including the Kitchin inventory cycle of thirty-nine months,the Juglar cycle of investment in plant and equipment that has a periodicity of seven or eight years and the Kuznets cycle of twenty years that highlights the rise and fall in housing construction.In the first two-thirds of the nineteenth century, crises occurred regularly at ten-year intervals(1816,1826,1837,1847, 1857,1866),thereafter crises occurred less regularly (1873,1907,1921, 1929) 24
c02 JWBK120/Kindleberger February 13, 2008 15:14 Char Count= 2 Anatomy of a Typical Crisis History vs economics For historians each event is unique. In contrast economists maintain that there are patterns in the data and particular events are likely to induce similar responses. History is particular; economics is general. The business cycle is a standard feature of market economies; increases in investment in plant and equipment lead to increases in household income and the rate of growth of national income. Macroeconomics focuses on the explanations for the cyclical variations in the rate of growth of national income relative to its long-run trend rate of growth. An economic model of a general financial crisis is presented in this chapter, while the various phases of the speculative manias that lead to crises are illustrated in the following chapters. This model of general financial crises covers the boom and the subsequent bust and centers on the episodic nature of the manias and the subsequent crises. This model differs from those that focus on the variations and the periodicity of economic expansions and contractions, including the Kitchin inventory cycle of thirty-nine months, the Juglar cycle of investment in plant and equipment that has a periodicity of seven or eight years and the Kuznets cycle of twenty years that highlights the rise and fall in housing construction.1 In the first two-thirds of the nineteenth century, crises occurred regularly at ten-year intervals (1816, 1826, 1837, 1847, 1857, 1866), thereafter crises occurred less regularly (1873, 1907, 1921, 1929). 24
Anatomy of a Typical Crisis 25 The model A model developed by Hyman Minsky is used to interpret the financial crises in the United States,Great Britain,and other market economies Minsky highlighted the pro-cyclical changes in the supply of credit, which increased when the economy was booming and decreased during economic slowdowns.During the expansion phase investors became more optimistic about the future and they revised upward their estimates of the profitability of a wide range of investments and so they became more eager to borrow.At the same time,both the lenders'assessments of the risk of individual investments and their risk averseness declined and so they became more willing to make loans,including some fo investments that previously had seemed too risky. When the economic conditions slowed,the investors became less op timistic and more cautious.At the same time,the loan losses of the lenders increased and they became much more cautious. Minsky believed that the pro-cyclical increases in the supply of credit in good times and the decline in the supply of credit in less buoyant economic times led to fragility in financial arrangements and increased the likelihood of financial crisis. This model is in the tradition of the classical economists,including ohn Stuart Mill,Alfred Marshall,Knut Wicksell,and Irving Fisher,whc also focused on the instability in the supply of credit.Minsky followed Fisher and attached great importance to the behavior of heavily indebted borrowers,particularly those that increased their indebtedness in the ex- pansion to finance the purchase of real estate or stocks or commodities for short-term capital gains.The motive for these transactions was that the anticipated rates of increase in the prices of these assets would ex- ceed the interest rates on the funds borrowed to finance their purchases When the economy slowed some of these borrowers might be disap pointed because the rates of increase in the prices of the assets proved smaller than the interest rates on the borrowed money and so many would become distress sellers. Minsky argued that the events that lead to a crisis start with a'displace- ment,'some exogenous,outside shock to the macroeconomic system.2 If the shock was sufficiently large and pervasive,the economic outlook and the anticipated profit opportunities would improve in at least one important sector of the economy.Business firms and individuals would
c02 JWBK120/Kindleberger February 13, 2008 15:14 Char Count= Anatomy of a Typical Crisis 25 The model A model developed by Hyman Minsky is used to interpret the financial crises in the United States, Great Britain, and other market economies. Minsky highlighted the pro-cyclical changes in the supply of credit, which increased when the economy was booming and decreased during economic slowdowns. During the expansion phase investors became more optimistic about the future and they revised upward their estimates of the profitability of a wide range of investments and so they became more eager to borrow. At the same time, both the lenders’ assessments of the risk of individual investments and their risk averseness declined and so they became more willing to make loans, including some for investments that previously had seemed too risky. When the economic conditions slowed, the investors became less optimistic and more cautious. At the same time, the loan losses of the lenders increased and they became much more cautious. Minsky believed that the pro-cyclical increases in the supply of credit in good times and the decline in the supply of credit in less buoyant economic times led to fragility in financial arrangements and increased the likelihood of financial crisis. This model is in the tradition of the classical economists, including John Stuart Mill, Alfred Marshall, Knut Wicksell, and Irving Fisher, who also focused on the instability in the supply of credit. Minsky followed Fisher and attached great importance to the behavior of heavily indebted borrowers, particularly those that increased their indebtedness in the expansion to finance the purchase of real estate or stocks or commodities for short-term capital gains. The motive for these transactions was that the anticipated rates of increase in the prices of these assets would exceed the interest rates on the funds borrowed to finance their purchases. When the economy slowed some of these borrowers might be disappointed because the rates of increase in the prices of the assets proved smaller than the interest rates on the borrowed money and so many would become distress sellers. Minsky argued that the events that lead to a crisis start with a ‘displacement,’ some exogenous, outside shock to the macroeconomic system.2 If the shock was sufficiently large and pervasive, the economic outlook and the anticipated profit opportunities would improve in at least one important sector of the economy. Business firms and individuals would
26 Manias,Panics,and Crashes borrow to take advantage of the increase in the anticipated profits asso- ciated with a wide range of investments.The rate of economic growth would accelerate and in turn there might be a feedback to even greater optimism.It's Japan as Number One'or the 'East Asian Miracle'or The New American Economy'- a new sense of more profound optimism about the economic environment.The words differ across the countries but the tune is the same. The nature of the shock varies from one speculative boom to another. The shock in the United States in the 1920s was the rapid expansion of automobile production and associated development of highways to gether with the electrification of much of the country and the rapid expansion of the number of households with telephones.The shocks in Japan in the 1980s were financial liberalization and the surge in the foreign exchange value of the yen.The shock in the Nordic countries in the 1980s was financial liberalization The shock in the Asian countries in the 1990s was the implosion of the asset price bubble in Japan and the appreciation of the yen which led to increases in the inflows of money from Tokyo together with financial liberalization at home.The shock in the United States in the 1990s was the revolution in information technology and new and lower-cost forms of communication and control that involved the computer,wireless communication,and e-mail.At times the shock has been outbreak of war or the end of a war,a bumper harvest or crop failure,the widespread adoption of an invention with pervasive effects-canals.railroads.An unanticipated change of monetary policy has been a major shock. If the shock is sufficiently large and pervasive,the anticipated profit opportunities improve in at least one important sector of the economy: the profit share of GDP increases.In the early 1980s,U.S.corporate profts were 3 percent of GDP;toward the end of the 1990s this ratic had increased to 10 percent.That corporate profits were increasing one- third more rapidly than U.S.GDP in turn contributed to the significant increase in stock prices. The boom in the Minsky model is fueled by an expansion of credit. In the prebanking seventeenth and eighteenth centuries personal credit or vendor financing fueled the speculative boom.Once banks had been developed they expanded the supply of credit and their liabilities;in the first several decades of the nineteenth century they increased the sup- plies of bank notes and subsequently they added to the deposit balances of individual borrowers.In addition to the expansion of credit by the established banks,new banks may be formed;the efforts of these new
c02 JWBK120/Kindleberger February 13, 2008 15:14 Char Count= 26 Manias, Panics, and Crashes borrow to take advantage of the increase in the anticipated profits associated with a wide range of investments. The rate of economic growth would accelerate and in turn there might be a feedback to even greater optimism. It’s ‘Japan as Number One’ or the ‘East Asian Miracle’ or ‘The New American Economy’—a new sense of more profound optimism about the economic environment. The words differ across the countries but the tune is the same. The nature of the shock varies from one speculative boom to another. The shock in the United States in the 1920s was the rapid expansion of automobile production and associated development of highways together with the electrification of much of the country and the rapid expansion of the number of households with telephones. The shocks in Japan in the 1980s were financial liberalization and the surge in the foreign exchange value of the yen. The shock in the Nordic countries in the 1980s was financial liberalization. The shock in the Asian countries in the 1990s was the implosion of the asset price bubble in Japan and the appreciation of the yen which led to increases in the inflows of money from Tokyo together with financial liberalization at home. The shock in the United States in the 1990s was the revolution in information technology and new and lower-cost forms of communication and control that involved the computer, wireless communication, and e-mail. At times the shock has been outbreak of war or the end of a war, a bumper harvest or crop failure, the widespread adoption of an invention with pervasive effects—canals, railroads. An unanticipated change of monetary policy has been a major shock. If the shock is sufficiently large and pervasive, the anticipated profit opportunities improve in at least one important sector of the economy: the profit share of GDP increases. In the early 1980s, U.S. corporate profits were 3 percent of GDP; toward the end of the 1990s this ratio had increased to 10 percent. That corporate profits were increasing onethird more rapidly than U.S. GDP in turn contributed to the significant increase in stock prices. The boom in the Minsky model is fueled by an expansion of credit. In the prebanking seventeenth and eighteenth centuries personal credit or vendor financing fueled the speculative boom. Once banks had been developed they expanded the supply of credit and their liabilities; in the first several decades of the nineteenth century they increased the supplies of bank notes and subsequently they added to the deposit balances of individual borrowers. In addition to the expansion of credit by the established banks, new banks may be formed; the efforts of these new