There is little doubt that the world faces the worst economic crisis since the 1930s, with a few economists and policymakers beginning to talk about the possibility of a depression. References to Keynesian economics are commonplace, with only committed free marketeers arguing against government intervention. Even the wizards on Wall Street are begging for re-regulation of financial markets. The Obama administration has projected current year federal budget deficits at $1.75 trillion (12% of GDP) and $1.17 trillion for 2010--although some private forecasters project $1.9 trillion for 2009, representing 13.5% GDP, and it is not likely that it will fall next year.

If anything, prospects facing the rest of the world are worse. The Fed has become the global lender of last resort, providing up to $600 billion in loans of dollar reserves to foreign central banks. Further, it is widely understood that the bail-out of US financial institutions (most prominently, of AIG) helps to protect foreign financial institutions (AIG is the biggest supplier of CDS "insurance" for debt held by European banks). Still, the run to relative safety in US treasuries has threatened exchange rates and increased risk spreads around the world. Social and political unrest is spreading around the periphery nations. Many economies will not recover until the US does. While I believe that the US has at its disposal ample policy space to resolve its crisis, many other nations do not. Mark Thoma has called for international coordination--a good idea, but one that I fear has little political support. Euroland will not expand its economy out of fear that markets will run out of its government's debts. And I think they would--since the Euro is not a sovereign currency for any individual Euronation.

All sorts of explanations have been proffered for the causes of the crisis: lax regulation and oversight, rising inequality that encouraged households to borrow to support spending, greed and irrational exuberance, and excessive global liquidity--spurred by easy money policy in the US and by US current account deficits said to flood the world with too many dollars. Hyman Minsky's work has enjoyed unprecedented interest, with many calling this a "Minsky Moment". I call it the Minsky half-century in recognition that the seeds of this crisis were planted 50 years ago.

We should not view this as a "moment" that can be traced to recent developments. Instead, as Minsky argued for nearly fifty years, we experienced a slow transformation of the financial system toward fragility that finally generated a systemic, global crisis. In the final years before his death in 1996, he had developed a "stages" approach to this evolution, identifying the current phase as "money manager capitalism"--vulnerable to crisis, with weakened safety nets so that a financial collapse would create an economic calamity. Indeed, we have had a long series of crises, and the trend has been toward frequent and more severe crises. This finally culminated in the booms and busts of the real estate market, the securitized products market, the commodities market and in credit default swaps and other derivatives.

In short, following Hyman Minsky I blame money manager capitalism--characterized by highly leveraged funds seeking maximum total returns (income flows plus capital gains) in an environment that systematically under-prices risk. With little regulation or supervision of financial institutions, money managers concocted increasingly esoteric instruments. It is largely the capital gain--not the underlying income flow--that rewards the money manager. Capital gains, in turn are relatively easy to fabricate given the opacity of the underlying assets--what Warren Buffet termed "financial weapons of mass destruction". These are then leveraged to purchase the rights to prospective income flows that purportedly underlie yet another asset class whose values can be bid up by managed money. Since each subsequent bust only wipes out a portion of the managed money, a new boom inevitably rises like a phoenix out of the ashes. However, this current crisis is perhaps so severe that it will destroy a considerable part of the managed money, thoroughly discrediting money managers.

In some important respects, the money manager form of capitalism represents a return of "finance capital" to its position of dominance--a position it had lost in the New Deal resolution of our last great depression. According to Minsky, that pre-1930s small government, laissez-faire economy failed. It was replaced by big government capitalism that was tolerably successful. Not only had government become a much bigger part of the economy, taken a bigger role in regulating and supervising business behavior, and provided numerous safety nets and guarantees, it had also promoted greater equality and growing incomes. All of this helped to stabilize the economy. However, over time our economy evolved a much more fragile financial structure subject to crises--as Minsky always argued, stability is destabilizing--because money managers and their representatives in government shredded New Deal constraints, substituting alternative goals.

I do not know what will replace money manager capitalism. The most important lesson policymakers should learn from the Great Depression and from the current collapse is that WE SHOULD NOT TRY TO RESTORE THE SYSTEM! Unfortunately, that is precisely what Larry and Timmy are desperately trying to do. They will fail.