An Economic Epilogue
TAUN N. TOAY
For many, the Great Recession was characterized by a series of acronyms, marked by intentionally opaque jargon: ABSs—asset-backed securities; CDOs—collateralized debt obligations; and the now infamous CDSs— credit default swaps. Even for industry insiders, these structured products were “innovations” in finance. A more efficient means of risk sharing had been born, or so it was argued, and further testament to the superiority of American (read “jungle”) capitalism.
Although the buildup to the recession characterized structured products (a euphemistic catchall term for the aforementioned acronyms) as a means to facilitate efficiency, the crash painted such products in a far different light. At best, structured products were complex instruments to extract high fees from clients in exchange for risk spreading; at worst, structured products were the ingenious instruments of criminals, drunk on greed and statistical software. In either case, they were not what they appeared—at least if you valued the input of rating agencies.
There are many ways to interpret the downturn and resulting chaos. Many point to Bear Sterns as the seed of instability or the failure of Lehman as the straw that broke the camel’s back. What was clearly at hand was a “Minsky Moment,” the term Paul McCulley of PIMCO coined to describe the catalysis of crisis.
Detailed in the Papadimitriou piece, Hyman Minsky was a Keynesian scholar who has enjoyed postmortem recognition for his work on financial instability. Minsky’s core premise was surprising simple: Firms fall into one of three classifications depending on the balance sheet of the firm—hedge firms, speculative firms, and, finally, Ponzi firms. The more firms at the latter end of the spectrum, the greater the financial fragility and a higher probability that an economic shock can send the system into chaos. To paraphrase Warren Buffett’s amusing analogy, “It is only after