Uncertainty, Competition, and Speculative Finance in the Eighties

Article excerpt

The dynamics of the financial system that lead to institutional change result from profit-seeking activities ... In this process innovation occurs ... transform(ing) the financial and economic system ... into one that (is) vulnerable to crises.

--Hyman Minsky 1986

It is widely recognized that the last 25 years have witnessed sweeping changes and upheavals in financial markets and institutions. But there is a radical disjuncture in scholarly writing about these developments. Neoclassicals and many other mainstream economists have seen greater market efficiency in the growth of the speed, diversity, and sheer size of financial flows. They have tended to ascribe any accompanying crises or crisis tendencies to excessive and misguided regulation [see, for example, Miller 1986; Jensen 1988.]. On the other hand, others have looked at the same innovations as producing instability, or even speculation unhinged from real economic activity. The critics have often attributed speculative destabilization to greed and ill-planned deregulation, although the more thoughtful have cited intrinsic evolutionary processes [Minsky 1977; Magdoff and Sweezy 1987; Galbraith 1993]. Recent work along these lines includes that by Carter [1989 1992], who examines the connections among technological change, economic uncertainty, and a number of recent financial innovations. Another series of investigations is by Wolfson [1986, 1990], focusing mainly on the banking industry's regulatory and competitive environment.

Here I present a view of recent financial change as a speculative, destabilizing process, with special theoretical attention to the actors' decision-making environment. I will trace the origins of the late 1970s and 1980s speculative episodes to competitive pressures dating from earlier developments in the financial markets. I attempt to complement the above sources with a broad historical and institutional sweep, and most importantly with a much closer look at the micro-environment of financial decision making--how, at the most basic level, we are to envisage economic agents whose actions are not only socially irrational, but self-destructive as well. I argue that explaining this behavior requires a theoretical focus on the nature and effects of competition. Competition in turn cannot be understood without recognizing that choice is uncertain, is guided by socially constructed conventions, and may be irreversible. These concepts are built around Keynesian notions of uncertainty and Marxian and Schumpeterian ideas of competition and innovation.

The theoretical framework is then applied to the emergence of speculative pressures in the 1960s and 1970s, especially the dynamics among the major segments of the financial sector (commercial banks, investment banks, and institutional investors). These changes occurred in the context of worsening performance in the real sector of the U.S. economy. With stable, long-term real sector ties disrupted by economic decline and bruising financial sector competition, financial institutions undertook a series of high-risk plunges--into Less Developed Country debt, the oilpatch, mergers, and commercial real estate. These episodes are described, with a focus on how they emerged from the pressures already recounted. I conclude by examining some implications for future research. The paper's emphasis will lie on developing a coherent and persuasive story rather than on critiquing the neoclassical account; the conventional framework is well known, and my chief aim is to specify the elements of an alternative. In addition, despite the importance of regulation and deregulation in shaping these events, I focus instead on the market dynamics that (as I will argue) created turbulence in and of themselves.

Uncertainty and Competition in the Financial Markets

We find ourselves compelled to strive after things which in a "calm, cool hour" we admit we do not want [Frank Knight 1921]. …