Minsky’s Cushions of Safety: Systemic Risk and the Crisis in the U.S. Subprime Mortgage Market

The current crisis in the financial systems of developed countries is often explained in terms of Hyman P. Minsky’s financial fragility hypothesis. Minsky was an economist at the Levy Institute and the foremost expert on credit crunches. His hypothesis was that the structure of a capitalist economy becomes more fragile over a period of prosperity; that is, endogenous processes breed financial and economic instability. In this brief, Senior Scholar Jan Kregel explains how the current crisis differs from the traditional Minsky hypothesis. He reviews Minsky’s concept of a margin or “cushion” of safety, financial fragility, and debt deflation. He concludes that, while the current subprime mortgage crisis involves both Ponzi financing and declining margins of safety, these conditions are not the result of endogenous processes. Rather, the crisis is the result of insufficient margins of safety based on how credit worthiness is assessed (the undervaluation and mispricing of risk) in the new “originate and distribute” financial system.