A conference organized by the Levy Economics Institute of Bard College with support from the FORD FOUNDATION

The Levy Institute’s Annual Hyman P. Minsky Conference will focus on post-recession exit strategies and the need for a new financial architecture. Registration deadline: April 8. For more information, including a list of participants, visit www.levy.org.

Pension funds have taken a big hit during the current financial crisis, with losses in the trillions of dollars and funding experiencing significant shortfalls. Yeva Nersisyan and Senior Scholar L. Randall Wray argue that the employment-based pension system leads to excessive cost and risk in an effort to achieve above-average returns. The best solution is to eliminate government support for pension plans and private savings, and to ensure that anyone who qualifies for Social Security will be rewarded with a comfortable retirement.

The authors therefore advocate expanding Social Security and encouraging private and public pensions to invest only in safe (risk-free) Treasury bonds. This approach would require a very small management staff, and would negate the use of fund managers and Wall Street sales staff.

The thrust of the U.S. policy response to the financial crisis has been to preserve what Hyman P. Minsky called the money manager phase of capitalism (i.e., financialization), with the bailout resulting in further concentration of the financial sector. These policies are doomed to fail, say the authors of this working paper, because the solution lies in downsizing the financial sector by two-thirds or more. The momentum for real change has been lost, and the policy response has sown the seeds for another crisis.

Nersisyan and Wray maintain that the government must not allow the financial industry to regulate itself nor its institutions to become “too big to fail.” Furthermore, insolvent banks should be resolved according to two principles: assuring the least cost to the FDIC, and downsizing in order to minimize the impact on the banking system. Other options include regulating securitized products, establishing a centralized clearinghouse for trading derivatives, forbidding banks to engage in securitization, creating a regulated exchange for financial derivatives—and prosecuting fraud.

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According to Senior Scholar Jan Kregel, the current approach to regulating the financial system is a series of cosmetic changes designed to remedy the conditions generated by a “Minsky moment.” However, the recent financial crisis and instability in the mortgage markets are byproducts of increasing fragility in the financial system—not a “moment” but rather a “process,” as described by Hyman P. Minsky’s financial fragility hypothesis.

Kregel identifies two types of systemic changes that reform must redress and reverse: the way that business financing (capital market instruments) has integrated banking and finance functions, and the way in which these instruments, by increasing financial layering, have reduced system liquidity and heightened fragility. His analysis concludes that it may be impossible to fully separate deposit-taking “commercial” banks from capital market activities if securitization is maintained as the basic financial structure.

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According to Research Associate Jörg Bibow, the dollar’s role must be a factor when assessing both the roots of the global financial crisis and the prospects for a sustained economic recovery. He proposes a “Bretton Woods III” regime that features a continuation of U.S. current account deficits driven by public spending and public debt that focuses on upgrading U.S. infrastructure—an arrangement that would require the Federal Reserve and Wall Street to maintain low financing costs. 

Bibow foresees a future where all major regions and players pursue domestic demand-led growth, and exchange rates are adjusted to balance global trade without any specific currency playing the dollar’s current role. The United States should design its macroeconomic policies to serve its own best interests, and focus on infrastructure investment in order to sustain domestic demand-led growth and avoid another private debt–driven boom-and-bust cycle. Furthermore, a compositional shift in demand (e.g., energy conservation and security) may help to contain the U.S. current account deficit.