The Shadow Banking System and Hyman Minsky's Economic Journey

Abstract

As we look for answers to the current financial crisis, it is clear that creative financing played a massive role in propelling the global financial system to hazy new heights—before it led the way into the depths of a systemic crisis. But how did financing get so creative? It did not happen within the confines of a regulated banking system, which submits to strict regulatory requirements in exchange for the safety of government backstopping. Instead, financing got so creative through the rise of a “shadow banking system,” which operated legally yet almost completely outside the realm of bank regulation. The rise of this system drove one of the biggest lending booms in history, and its collapse resulted in one of the most crushing financial crises we have ever seen. Perhaps the most lucid framework for understanding this progression comes from the work of Hyman Minsky, the mid-20th-century U.S. economist whose theory on the nature of financial instability proved unnervingly prescient in explaining the rise and fall of shadow banking—and the dizzying journey of the global financial system over the past several years.

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