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In writing about financial crisis, a perennial topic and the one that oriented Minsky’s career, two points in time inevitably loom large: the next crisis and the last. Knowing that they come about, if not cyclically, at least repeatedly, it is hard to resist the temptation to imagine what will be the next crisis. Minsky’s work, as we shall see in some detail, helps us see how financial traumas grow from the quiescent periods that precede them; but having recognized this fact, one can quickly spot the seeds of crisis all around. This is not the same, however, as being able to offer a precise prediction. For these reasons I have tried, in what follows, to avoid predicting the next crisis; we shall have to wait and see.

The last crisis stands out in memory; indeed, a decade on, the debates and headlines that occupy the world’s attention today can still be traced along quite short paths back to the events of 2008. The subprime crisis, or the global financial crisis of 2008, was a major disruption: from a tipping point in the market for US real estate, it exposed the fragile arrangements in a global market-based credit system, bringing about the failures of major financial institutions, sparking a crisis in sovereign debt, and requiring coordinated intervention by central banks around the world. The consequences for employment, public finances, investment, not to mention politics and even, arguably, the course of history, have been and continue to be great. At the same time there is a risk of driving in the rear-view mirror, of preparing for the last war. Financial crises have a strong family resemblance, and at the same time each is unique; Minsky’s work, I argue, is more about the family resemblance than about any particular crisis, 2008 included.

I have aimed, therefore, to keep 2008 as an important example, but not the focus, for most of the book. Chapter 7 takes up the subprime crisis as a context for understanding the resurgent interest in Minsky’s work. Examples from the FCIC of the US Congress are included throughout the book as illustrations, in many cases quite precise ones, of Minsky’s insights. This section anticipates the discussion to follow with a short look at the events of the 2008 crisis. (I have tried to make this narrative both complete and efficient; as a consequence I fear it is slightly technical for an introductory section. To the interested reader for whom some of the financial vocabulary may be daunting, I suggest that you feel free to skip or skim this section. Its value might lie mostly in that it summarizes the events of the 2008 crisis from a viewpoint theoretically consistent with the other chapters of this book, and so I also suggest that you come back to it at the end.)

One of the signal developments in the world of finance in the decades leading up to 2008 was a shift from a bank-credit-based to a market-based financial system; borrowing and lending that had been conducted via customer relationships at commercial banks came, more and more, to be conducted instead via the exchange of securities. The year 2008 can be understood as the first major crisis of this new, market-based financial system. These developments in banking were driven in particular by the rise of money-market mutual funds (1980e). Money funds emerged beginning in the late 1960s, and their usage grew as a response to the demand for high interest rates as compensation for rising price levels in the high-inflation years that followed. They sought to provide the benefits of bank deposits – stable value and ready convertibility into cash – while paying an interest rate above the Depression-era Regulation Q caps, upper limits on interest rates set by the Federal Reserve, that bound commercial banks. They operated as mutual funds, issuing shares and using the proceeds to purchase securities. Though money funds were not insured, as commercial bank deposits were by the Federal Deposit Insurance Corporation (FDIC), they succeeded in displacing the bank credit that had dominated.

As depositors’ business moved from commercial banks to money funds, borrowers’ business moved from commercial loans to commercial paper – short-term securities issued by companies to finance their immediate cash needs. Issuers were able to place their commercial paper with money-market funds, which in their turn needed securities to hold. Bank-based credit was thus displaced by market-based credit; the normal banking transaction was now the issuance of commercial paper matched by the issuance of money-market fund shares, rather than the creation of a bank loan matched by an increase in deposits.

Viewed in the abstract, the two approaches to finance, bank-based and market-based, are not so different. In practice, however, they interacted differently with the institutional environment. One important set of institutional developments was around regulation – indeed the very fact that money funds were not bound by interest-rate ceilings was the main factor behind their growth. Another relevant regulatory shift was the 1999 repeal of the 1932 Glass–Steagall Act, which had kept commercial banks out of securities-based banking. The expansion of market-based credit went along with a general decline in the regulation of the financial system; financial markets were left to their own devices.

A second set of institutional changes relates to the financial usages that supported securities-based banking. One of the institutional advantages of market-based credit over bank loans was that securities could readily trade in secondary markets: the initial purchaser of newly issued commercial paper was not obligated to hold it to maturity, as was the case for bank loans, largely unmarketable. Such markets were made by securities dealers, who bought and sold such securities. The existence of these markets seemed an unmitigated good: knowing that the position could readily be liquidated, potential lenders would enter the market more willingly, and borrowers would benefit from more competitive rates and smoother issuance. Securities dealers thus became more central to the flows of credit; their business was in turn supported by the growth in repurchase agreement (repo) markets. A sale-and-repurchase agreement is a short-term loan of cash, secured by a financial asset: the owner of the asset can post it, overnight or for a very short term, as collateral for a loan of cash. The repo market facilitated the short-term holdings needed by securities dealers.

As money-market funds seemed to improve on bank deposits, the market-based credit system seemed to improve on the bank-based system, and it grew accordingly. An innovation that would prove critical in 2008 was securitization: a group of financial assets was pooled, the cash flows generated by them assigned according to a structured issuance of securities. It is market-based banking taken to its logical conclusion – a purely financial entity that fit easily into the infrastructure and usages of market-based finance. There was much to argue in favor: as Minsky had said (two decades earlier), it “makes the steps in financing explicit. It allows separate organizations to carry out the steps that were previously folded into banks and other financial intermediaries. Securitization will obviously impose a dynamics to financing that may well lead to a greater decentralization and variety of forms of financing than now exists” (1990b, 65).

In a way, this is just banking: instead of a commercial bank funding a portfolio of loans with deposits, it is an investment vehicle funding a portfolio of bonds with securities. One innovation that seemed even to improve upon institution-based banking was that a single securitization vehicle could issue a range of liabilities with different levels of debt seniority. This was the most alchemical of achievements of the market-based credit system, for it meant that a set of even doubtful assets could be the basis for the issuance of high-quality, money-like securities, perfect for the portfolios of money-market investors seeking an alternative to cash. The most junior tranches of securitizations could even serve as the basis for a second-order securitization, thus the collateralized debt obligation (CDO).

Securitization reached its high-water mark in the US real-estate market; the steady origination of mortgages was a supply that could meet the steady demand for mortgage-backed securities. The availability of such wholesale funding supported the issuance of large amounts of new mortgage financing, which in turn supported a steady rise in home prices. The appreciation of real-estate prices meant that borrowers could readily sell into a rising market in the event of payment difficulties. As a result the increased lending seemed sustainable, and moreover seemed to support the wholesale financial innovations underlying the expansion of retail lending. In the final phase of the housing boom, demand for mortgage securitizations was great enough to impel a relaxation of lending standards: confident that any level of issuance would be absorbed, mortgage originators sought to lend to anyone and everyone, even those “subprime” borrowers with little or dubious credit history.

A final innovation that accompanied and enabled the rise in securitized finance was the use of credit-default swaps (CDS), which can be understood as insurance policies on market-based credit instruments. A CDS contract is written between a buyer and a seller, with reference to a security issued by a third party. The buyer of CDS pays the seller a periodic premium; in the event of default by the issuer, the seller of CDS pays the buyer a principal. It functions as insurance against default, but because one can take a position in CDS with no interest in the underlying security, such swaps also provided an inexpensive vehicle for speculation. CDS can be written against any security; CDS on mortgage-backed securities played an important role in the expansion of market-based credit before the crisis of 2008.

Elements of the market-based credit system had been tested, in particular during the 1970 crisis in the commercial paper markets, and the 1982 crisis in the repo market, but in retrospect these were little more than bumps in the road. Repo, commercial paper, securitization, and credit-default swap markets grew significantly over the subsequent decades, and became closely connected to the boom in residential construction and mortgage finance. In general, despite the anxieties of some, the US financial system seemed, in the early 2000s, more stable than at any time in the past, and the peaks and troughs of recessions had lessened, dubbed the “Great Moderation.”

The crisis unfolded in stages from early 2007 to its apex in September 2008. In the early stages of the crisis, payment problems associated with some of the most adventurous mortgages – the subprime segment of the market – began to emerge, casting doubts over the US real-estate market more broadly. Concerns simmered about the housing market, about the extent of market-based credit that had been extended on the basis of housing loans, and about the potential of losses in these markets to affect major financial institutions. Disruptions in funding markets were evident but the extent of the crisis was not yet widely known. Broadly speaking, owners of mortgage-backed securities were beginning to seek an exit from these positions, and securities dealers, as the proximate intermediaries supporting such business, accommodated this exit by purchasing the securities from those who wished to sell. The dislocation was evident in short-term interest rates, in particular in the cost of repo borrowing against Treasury collateral, which became very cheap relative to borrowing against mortgage-backed security collateral. Borrowing was still possible, but anxiety about financial stability was becoming widespread.

The Federal Reserve (the Fed) did not offer major interventions in the early stages of the crisis. In March 2008, however, the hastily arranged acquisition of investment bank Bear Stearns by its erstwhile competitor JPMorgan Chase marked a shift to a more acute period, and the central bank increased its efforts to support the financial system. Recognizing that the rise of securities-based finance meant that securities dealers were the key intermediary, evident in spiking borrowing costs and increasing dealer reliance on short-term borrowing, the Fed aimed to support a general exit from mortgage-related assets by easing dealer financing conditions. It offered a range of special credit facilities to shore up dealer finance directly or indirectly through dealers’ banks. Notably, the Fed deployed its own, pre-existing reserve of Treasury securities to fund these interventions, without expanding its balance sheet from its pre-crisis size of just under $1 trillion.

These interventions calmed markets for a time, but September 2008 brought a new wave of failures, bringing the crisis to its peak. The government-sponsored enterprises Fannie Mae and Freddie Mac, instrumental in providing mortgage finance in the US, were placed in receivership on September 7; investment bank Lehman Brothers, heavily exposed to mortgage-backed and other securitized credit, declared bankruptcy on September 15; and insurance company American International Group (AIG), with extensive CDS business, declared bankruptcy the following day. Other institutions, large and small, in the US and internationally, seemed to be in jeopardy. Financial markets came to a halt. The Fed responded with a much more direct presence in the market-based credit system. It rapidly expanded its support to banks and dealers, expanding its balance sheet by $1.4 trillion by December 2008 (with a further $2 trillion to come by January 2015). The special liquidity programs were unwound over the course of 2009, as the central bank settled eventually on the absorption of much of the US mortgage market onto its own balance sheet. By expanding dealer finance, and then acting as a dealer itself, the Fed absorbed major parts of the global money markets onto its own balance sheet; it purchased a huge swath of the market-based credit system (Grad, Mehrling, and Neilson 2011; Mehrling 2010).

The interventions did resolve the acute phase of the crisis, though the wider repercussions were still severe. It is difficult to bracket the endpoint of the crisis – in the US, it led to a major recession. The pre-crisis unemployment rate was not seen again until 2017; the pre-crisis employment-to-population ratio remains distant as of this writing (2018). In Europe, the US events contributed to an extended crisis in sovereign debt, in turn shaking the foundations of the eurozone and the European Union. The contraction and financial disruptions were felt around the world. The populist and proto-fascist political movements that have come to prominence in 2008’s wake surely owe some of their rise to resentments stemming from the crisis and its aftermath.

The crisis prompted wide reflection on the excesses of the boom, on the appropriate scale of the financial system, and on the sustainability of capitalism itself; these reflections continue as 2008 is interpreted in light of what has followed. As a consequence, the work of Hyman Minsky, who argued that “stability is destabilizing,” has been seen as relevant once again: his books were republished, and a range of interpretations have been advanced. This book is more about Minsky’s work than it is about 2008, but my own education, and so my interpretation of Minsky, have been strongly shaped by the events described in this section. I shall return to Minsky’s role in current debates toward the end of the book; for now I turn to the main event.