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Relevant except from Hyman Minsky:

Although present value reversals occur-they certainly did in the 193Os and again to a much more limited extent in 1974-75 and 1981-82-the cyclical contractions and expansions of investment activity do not depend upon this extreme case. It is enough that the margin between the price of capital assets and the supply price of investment, inclusive of financing costs, varies inversely with interest rates. A regime of low short- and long-term interest rates will lead to a large margin between the two prices, which leads to a high ratio of external to internal finance. This increases investment and profits, and the willingness to engage in debt financing of capital asset positions. Thus, there are strong internal destabilizing interactions in any economy in which financial markets are part of the mechanism by which investment is determined.

As I understand it, this is essentially asserting that:

  1. The health of a firm's balance sheet forms part of a creditor's willingness to lend.
  2. Which takes both the form of the NPV of its core business and also the firm's liability structure (issuing more debt will dilute share/bondholders from that core NPV or "capital asset" as Minsky terms it)
  3. The net cashflow position (after factoring in financing costs) is said to be inversely related to interest rates
  4. This somehow results in greater reliance on equity/bond issuance, which Minsky argues is inherently a destabilizing force when examining the overall stability of the economy.

However, my intuition is that lower rates would have the opposite effect. A significantly low cost of capital would surely be more favorable for whatever project/business proposition the firm would be considering. This would widen the margin of safety in that the project has a lower hurdle rate. A higher interest rate, to me, seems like a mechanism to introduce instability in that the terms / covenants may be too much to handle for a modest / average business.

Edit Perhaps it is not just about low rates but rather having emphasis on low short and long-term rates: a flat yield curve. But I'm still struggling to understand how a flat yield curve will lead to a high ratio of external to internal finance. I know what he means by in/external financing:

  • Internal: Profits/income receipts
  • External: Debt/equity issuance

Maybe its the "large margin between the two prices" that is tripping me up. If the yield curve is flat, surely the carry is near depletion not a "large margin" environment.

Question

I've already made my peace about being wrong: it's Minsky after all. Still, I can't figure out his logic; can somebody explain what I have missed and why Minsky's assertion that a flat yield curve leads to greater reliance on external finance? Ideally keep it simple/less mathematical.

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The best I have so far is that:

  1. On paper, a flat yield curve would imply a lower hurdle rate. This makes more projects financially feasible.
  2. However, for some businesses, namely banks, a flat yield curve would take away their carry.
  3. If businesses can secure attractive short/long-term financing they will do so, perhaps even aggressively. This may have dilutive effects on stake holders and will as Minsky suggests increase the ratio of external financing to internal financing
  4. The instability comes as a result of any time there are sufficient conditions to leverage up on debt based on any non-negative NPV/capital assets/gross profit. In a rational (though somewhat predatory and morally questionable) economy, such capital assets are basically screaming to have their cash flows absorbed by debt instruments: to not do so would forego an arbitrage opportunity. (From the context of financial services companies)
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