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The presidential administration’s policy is destabilizing what had been a stable U.S. economy. For this reason, all of us would be well advised to revisit Hyman Minsky’s great work Stabilizing an Unstable Economy.
Minsky developed a concept called the “financial instability hypothesis.” The FIH proved to be prescient in the periods leading up to several financial crises, especially the financial crisis of 2008-2009. With this in mind, consider what the FIH has to say about the degree to which the current U.S. economy is financially fragile. To do so, consider a series of diagnostic questions and related answers. Collectively, this Q&A exercise suggests that in 2025 the U.S. economy has become more fragile.
Does the U.S. economy feature excessive leverage? Certainly, the size of the federal government’s deficit, and associated debt, have been drawing a great deal of attention. At present, the federal budget deficit is approximately 7% of gross domestic product, and needs to be closer to 3%. Over the next decade, annual budget deficits are projected to double, and since 2021, annual interest costs on the federal debt have nearly tripled. Interest costs of the federal debt currently comprise the second largest budget item after Social Security. Without changing course, within a decade, interest costs are likely to absorb nearly a third of all annual tax revenue. The president’s tariffs have generated some revenue to reduce the deficit, but not nearly enough. However, they have generated a great deal of uncertainty and potential inefficiency.
How significant is financial activity in the shadow banking sector? Minsky’s concern about shadow banking, what he called “fringe” financial institutions, is that their activities lie outside the purview of financial regulators, thereby leading these institutions to take on leverage and risk, with the commercial banks as their lender-of-last resort. An example of fringe finance is the private credit market, where corporations borrow directly from non-bank lenders. Private credit markets have been experiencing rapid growth, raising concerns about opacity and potential risks. Crypto assets also qualify as fringe finance, and have drawn a great deal of attention since President Trump promised to make the U.S. the crypto capital of the world.
To what extent are investors betting on price appreciation rather than cash flows to repay interest and principal? Minsky described reliance on price appreciation as “Ponzi finance.” He argued that a major contributor to financial instability is short-term lending by financial institutions against long-term assets, where repayment of the interest as well as the principal on the debt depends heavily on asset price appreciation rather than the generation of cash flows. Just as a Ponzi scheme collapses without sufficient cash inflows from new investors, Ponzi finance collapses without sufficient price appreciation for the asset being financed. Lower lending standards in private credit markets can give rise to Ponzi finance. Likewise, crypto markets can feature Ponzi finance when trading platforms offer high leverage. In respect to financial fragility, concentrated redemptions during market downturns are prone to trigger market instability.
Is the market experiencing a surge in financial innovation and overvaluation of asset values? Minsky argued that the financial sector uses innovation as a tool to increase leverage and risk. He emphasized that during the evolution of a boom, the shift from prudent lending standards, which he called “hedge finance,” to speculative and Ponzi finance fuels the creation of price bubbles for particular assets. This creates a feedback loop in that these asset bubbles encourage additional reliance on Ponzi finance and short-term lending for the financing of long-term assets. Examples of financial innovation are lower lending standards in private credit markets, as mentioned above, and smart contracts in crypto markets. As for overvaluation of asset values, there are many potential candidates. Besides the private credit market and crypto, the list includes investment in AI, meme stocks, and segments of commercial real estate.
Are there arguments being advanced to suggest that rising asset prices are justified by fundamentals, and that this time is different? Minsky explained that during an economic boom with rising asset values, people concoct new era explanations, consistent with free market ideology, to justify the inflated asset prices. Within the world of social media, it is relatively easy to find strong messaging that the booms in AI and Bitcoin will soon generate a massive bull market.
Is regulatory oversight weakening? Minsky argued that during booms, free market ideology permeates the mindset of regulators. He was very concerned that the Fed has historically over-focused on monetary policy at the expense of overseeing the quality of lending in financial markets. This focus, he suggested, leads regulators to fail at their task. A particular concern of his was that regulators would fail to monitor the degree of Ponzi finance in the financial system. In the current political climate, the Trump administration, with the support of the Supreme Court, is dismantling regulations across the board. In particular, the president is seeking to bring Fed decision making under his control, instead of allowing it to function independently. The president is particularly keen to have interest rates come down significantly. Minsky lived through the period of the 1970s, when the Fed did engage in overly expansionary monetary policy, with the end result having been very high inflation.
All six of the Minsky FIH-diagnostics point to the U.S. economy and financial system becoming more fragile, as a result of current policy. There are two takeaways from the analysis. First, increased fragility implies increased risk. That is, there is a significant risk of a financial crisis in the short-to- medium term. Second, increased fragility implies increased severity. That is, the magnitude of a crisis, if it materializes, is likely to be substantial.
