Research Proposal for Graduate Thesis – The 2007 Global Financial Crisis – A Political Economic Analysis

Aug 26th, 2009 by Riaan Nel in Graduate Research

I have been absent posting on the blog due to focusing on the finalization for my Research Proposal for my graduate thesis.  I am currently enrolled in the Masters program at Stellenbosch University.  I am participating in the research based thesis program.  I decided to post my draft Research Proposal for commentary…

  1. Introduction[1]

On Thursday, August 9, 2007, traders in the international money markets in New York, London and other prominent financial centers experienced a sudden and dramatic surge in interest rates for medium-term interbank loans relative to interest rates for overnight interbank loans (Taylor & Williams, 2008:1). In the global economy the supply of credit is influenced by the London Interbank Offered Rate (LIBOR), a daily reference rate of interbank loans contracted in the London wholesale money market. A surge in the LIBOR has implications for the availability and cost of credit throughout the global economy.

The three-month LIBOR Overnight Index Swap (OIS)[2] for this period dramatically illustrates the extent of the developing crisis. The three-month LIBOR-OIS rate is a measure of what the markets expect the US federal funds rate to be over a three-month period relative to the three-month LIBOR[3]. The LIBOR-OIS spread is used to indicate factors, other than interest rate expectations, influencing interbank rates, such as risk and liquidity factors (Taylor, 2009:15). Historically the spread has been 11 basis points on average, but on August 9, 2007, the spread surged to 34 basis points, fluctuating wildly between 30 basis points and a maximum of 106 basis points over the preceding months (Taylor & Williams, 2008:10-11).

This surge in interbank medium-term rates was the onset of unprecedented deleveraging throughout the global economy. Global finance was in the grip of a liquidity crisis, which eventually resulted in worldwide economic contraction and recession, accompanied by bank failures, the implosion of the real estate markets in many countries, specifically the US, and rising unemployment.

It is the aim of my proposed study to explain the causes of this financial crisis. This Research Proposal will explain the background, historical context and importance of the 2007 Global Financial Crisis. The Proposal will formulate a specific research question that will guide the proposed study, as well as formulate an explanatory hypothesis regarding the crisis.

The Research Proposal will outline the theoretical framework for the proposed study. Issues of ontology and epistemology will be addressed, as well as a discussion of the delimitations and limitations of the proposed study. The Proposal will end with a chapter outline and a time frame for the proposed study.

2. Background and Importance

As mentioned above, the 2007 Global Financial Crisis commenced with a sudden and unprecedented surge in medium-term interbank rates in the world’s money markets on August 9, 2007. Taylor (2009) argues that the sudden surge in interbank interest rates was caused by counterparty risk, meaning banks became more reluctant to lend to other banks because of the perception that the risk of default on loans had substantially increased, and therefore the market price for such risks had to increase.
Through the remainder of 2007 the world’s credit markets started to “freeze up” – the supply of credit started shrinking at an alarming rate. Credit contraction, or deleveraging, rapidly spread through the global financial system. The world’s banks and large financial institutions stopped making loans, and financial deals all over the world could not be closed. The source of the counterparty risk was fear of losses in the US subprime mortgage market (Smick, 2009:10-11). Smick (2009) and many others, were confounded as to why, at the onset of the crisis, losses and potential losses of at most $200 billion in a global market of hundreds of trillions of dollars had such a severe credit impact.
Many observers believe that the reason a very small segment of the global financial system had such a severe credit inhibiting impact is related to the extent of global financial integration, specifically through the process of securitization (Ferguson, 2008; Morris, 2008; Smick, 2009). Global financial integration is an important aspect of what has come to be known as globalization.
The structure of global capitalism has evolved from disparate regional, relatively autonomous markets for goods and services, to single interdependent markets for goods and services, which integrates nearly the entire world in a system of resource allocation that is characterized by complex interdependence. Cohen (2008:79-80) defines globalization as follows:

“… globalization is equated with an increasingly close integration of national markets – a fundamental transformation of economic geography. In place of territorially distinct economies, we are said to be moving toward a more unified model, a truly global marketplace. Production processes and financial markets are becoming more international, transcending space. Economic networks are spreading without regard for distance or borders. Transactions are speeding up, compressing time, and relations are growing more and more intense, deepening linkages.”
The process of securitization played an important role in the ever-increasing financial integration evolving within the capitalist system. Securitization is a financial innovation whereby individual debts, like mortgages, are tranched and then bundled together. These tranched and bundled debts are repackaged and sold to individual and institutional investors across the world. Through an integrated global financial market securitization linked lenders to borrowers all over the world.
It is against this background that the 2007 Global Financial Crisis must be analyzed. It is important to distinguish between the concepts of money and finance. Susan Strange’s analytical distinction is useful: money is considered as the determination of currency values together with the system used to exchange currencies, while finance is the system whereby credit is created, bought and sold (Germain, 1997:17). At the heart of finance is credit. Financial historian, Niall Ferguson (2008:3) considers the evolution of credit and debt as important as any technological innovation during the rise of civilization:

“Banks and the bond market provided the material basis for the splendours of the Italian Renaissance. Corporate finance was the indispensable foundation of both the Dutch and British empires, just as the triumph of the United States in the twentieth century was inseparable from advances in insurance, mortgage finance and consumer credit” (Ferguson, 2008:3).

The mere fact that mortgage loans were securitized and sold throughout an integrated global financial system could not in and of itself cause the credit crisis. An important component of the credit crisis was the housing bubble – that is, the unprecedented run-up in the price of real estate, particularly residential real estate, in many parts of the world.
It is important to note that it is notoriously difficult to define a bubble. Not all asset price increases are “bubbles.” In the proposed study a bubble is seen as an upward price movement over an extended range that then implodes due to an upward deviation from the fundamentals of the asset being priced (Kindleberger, 2000:15-16.) However, let us not forget that fundamentals, like beauty, are in the eye of the beholder.
Financial bubbles are common in capitalist economies. Ferguson (2008:122) identifies a number of recurrent features of this phenomenon. Two of these are very pertinent to the evolution of the 2007 Global Financial Crisis. There is the role of cross-border capital flows – bubbles are more likely to occur when financial capital flows freely from country to country. Another important feature relates to the creation of credit:

“… most importantly, without easy credit creation a true bubble cannot occur. That is why so many bubbles have their origins in the sins of omission or commission of central banks” (Ferguson, 2008:122).

The proposed study’s importance lies in its explanation of how credit expansion within a globalized financial system moved investments into real estate loans in many parts of the world through the securitization of mortgage debt, causing a significant increase in the price of real estate, which subsequently collapsed. Doubt about the value of securities linked to mortgages led to the so-called “Black Swan” that landed in the money markets on August 9. Central banks and governments were key players, especially in the US where the crisis originated, thus, it is essential to understand the critical political decisions that factored into the unfolding of the crisis.
Credit expansion is the key independent variable in causing the 2007 Global Financial Crisis. Although a real estate bubble precipitated the crisis, it was a preceded by a credit bubble. Factors leading to this global credit bubble are, inter alia, the following:
• The expansion of the global capitalist system after the fall of the Berlin wall led to greater competition in global manufacturing and services, which reduced real wages globally, lowering inflationary expectations, which resulted in declining long-term interest rates. Lower interest rates make credit more affordable.
• After the 2000 tech bubble induced recession in the US and the September 11 attacks, the Federal Reserve kept the federal funds target rate very low. The rate was 6.5% at the beginning of 2001, and was lowered to 3.5% at the time of the September 11 attacks. At the end of 2001 the rate was at 1.75%. The continued deterioration of the US economy and fears of Japan-style deflation, motivated the Federal Open Market Committee (FOMC) to drop the rate to 1% and keep it there until June 2004. Once the FOMC started increasing the rate, it was very timid, only reaching 3% in May 2005. On February 6, 2006 when Federal Reserve Chairman, Allan Greenspan, retired, the federal funds target interest rate was 4.7%.
• In the emerging world, specifically Asia, there was a “savings glut”, to use the new Chairman, Ben Bernanke’s term. The global savings glut was caused by a shifting of investments away from Asian countries in the aftermath of the 1997 Asian financial crisis; by the accelerated increase in the price of oil, creating massive surpluses of Petrodollars; and by the currency management system of some countries, specifically China, creating dollar surpluses in an effort by “currency pegging” countries to keep the value of their currencies artificially low vis-à-vis the US dollar.
• Many US corporations had increasing retained earnings after the collapse searching for investment opportunity.
• Financial globalization and financial innovation increased the velocity of investment capital gushing through the global financial system.
• Unstable debt regimes evolved during the so-called Great Moderation of the 90′s and 2000′s, characterized by financial institutions creating off-balance sheet financial vehicles to circumvent the Basel standards, leading to irresponsible levels of leverage.
These factors, and others, led to an unprecedented increase in global credit which was searching for yield in a low yield environment, finding its way into mortgage related securities, and causing a fundamental mispricing of mortgage related risk. It is this mispricing which ignited the crisis.

The crisis reignited a debate about the role of the state in markets. For almost 30 years it seemed that the view of the monetarists held sway. Gamble (2009) aptly describes the rise of the so-called “financial growth model” starting in the 1980s, specifically under the Reagan and Thatcher governments:

“This new financial growth model used tax cuts to stimulate the economy, and it promoted privatization of public assets and deregulation of the private sector, particularly the financial sector. It sought to expand credit, not restrict it, and to enlist the financial sector as the most important driver of growth and competition in the economy. It led to the rise of the investment banks and the rating agencies to their commanding position in the global economy at the beginning of the twenty-first century, and the proliferation of new financial vehicles and instruments, a readiness to ‘leverage’ every asset whether in the public or private sector, and to make all citizens and organizations ‘financial subjects’” (Gamble, 2009:15).

This type of model, referred to by Strange (1986) as “casino capitalism,” flourished, particularly in the English-speaking world – the so-called Anglo-sphere economies. The 2007 Global Financial Crisis is challenging decades-old political economic orthodoxies, and is redefining the role of the state in markets. Understanding the crisis is critical to the current discussion on the restructuring of global finance.
The importance of the issue to be addressed by the proposed study is highlighted by the argument that the 2007 Global Financial Crisis is part of a larger crisis within capitalism itself that has been brewing for many years (Gamble, 2009). By the beginning of 2009 many of the leading national economies were in recession. The IMF predicted in January 2009 that the recession for advanced economies was likely to be the worst since the Great Depression. See Table 1 below.

Percentage changes in GDP, 2007 and 2008, and projected changes, 2009 and 2010
2007 2008 2009 2010
World Output 5.2 4.3 0.5 3.0
All Advanced Economies 2.7 1.0 -2.0 1.1
All Emerging and
Developing Economies 8.3 6.3 3.3 5.0
(Source: Gamble, 2009:36; data from IFM World Economic Report 2009.)

The 2007 Global Financial Crisis impacted every country in the world. Data is scarce regarding the human impact, but it is estimated that there will be 90 million more people living in extreme poverty by the end of 2010 due to the global contraction (Alexander, 2009).
In trying to stem the tide of the crisis, governments and central banks have taken unprecedented steps, fundamentally changing the global political economy. Ultimately, the importance of this study lies in making a small contribution to the way the crisis is perceived. As Gamble (2009:65) argues, the way we perceive a crisis is always a political act, since it authorizes certain courses of action to resolve the crisis and restore stability or create a new order.

•3. Problem Statement and Hypothesis

The central problem of my proposed study will be to answer the following research question: What caused the 2007 Global Financial Crisis?

In answer to this question I am postulating the following hypothesis: Within the structural evolution of capitalism there occurred an unprecedented expansion of credit in the years preceding the 2007 Global Financial Crisis, which caused a fundamental distortion in the price of mortgage risk.

I will name this hypothesis the Credit Expansion Mispricing of Mortgage Risk Hypothesis. Once the reality of mispriced mortgage risk started to spread through the financial system, it caused panic and confusion regarding the true extent of the risk. The panic and confusion surrounding the correct price of mortage risk caused global deleveraging, resulting in a global recession. The proposed study will illustrate that mispricing was largely caused by global credit expansion.

A secondary research question that will be addressed is: What are the lessons of the 2007 Global Financial Crisis for government policy?

In answering the second research question only tentative observations on government policy related to financial crises will be made in the proposed study. It is outside of the scope of the proposed study to address the issue in broad detail. The study will suffice with highlighting the important factors relevant to government policy gleaned from an understanding of the fundamental causes of the crisis within the theoretical framework to be applied.

•4. Delimitation and Limitations of the Proposed Study

From the proposed study’s vantage point the academic discipline to which the 2007 Global Financial Crisis adheres is Political Economy. Political Economy is defined as the study of how resources are allocated by humanity. The study will make the argument that there are two primary dimensions of resource allocation, namely the “political” and the “economic.”

The political dimension of resource allocation relates to the sub-systems of power and authority within societies. The economic dimension relates to the sub-systems of production and distribution of resources within societies. These two dimensions, or sub-systems are interdependent and interactive. The sub-systems of production and distribution of resources within societies influence the sub-systems of power and authority within societies, and vice versa. These sub-systems together form the overarching systems of resource allocation within societies.[4]

If one takes the entire world as one spatial entity, the global system of resource allocation is characterized by the existence of fragmented sub-systems of power and authority – the nation states[5]; and the increasing integration of the production and distribution of resources spanning national boundaries.[6] Although political power and authority predominantly rests in the hands of sovereign nation states and there is an absence of a central governing authority in the world, institutions and regimes play important roles in the system for resource allocation (Keohane, 2002.) I refer to the study of the global system of resource allocation as Political Economy (upper case) - and the global system of resource allocation, itself, as political economy (lower case).[7] One could also refer to the study of this system as International Political Economy to distinguish it from studying the allocation of resources in one specific region, or one nation state’s system. Simply using the term Political Economy is preferable, in my mind, as it is a semantic effort to move away from the rigid disciplinary walls academia has constructed.

The 2007 Global Financial Crisis is a phenomenon that occurred within the world’s system of resource allocation. The proposed study will continue the trend Palan (2000) identified within the discipline of International Political Economy (IPE), with IPE returning to its Political Economy roots. Palan (2000:2-3) quotes Gilpin’s 1987 definition of International Political Economy as containing an unsatisfactory implicit assumption, namely that politics and economics are two separate, indeed, parallel realms:

“The parallel existence and mutual interaction of ‘state’ and ‘market’ in the modern world create ‘political economy’ … In the absence of state, the price mechanism and market forces would determine the outcome of economic activities; this would be the pure world of the economist. In the absence of market, the state or its equivalent would allocate economic resources; this would be the pure world of political scientist.”

According to Palan (2000) this challenge to bridge the divide is responsible for a

theoretical realignment occurring in IPE. To answer the first research question I will need to bridge the politics-economics divide. The proposed study will argue that this divide has had an overly reductionist impact on the type of answers economists and political scientists have produced in explaining social phenomenon. This divide is an old leftover from the dominant nineteenth century liberal ideology that defined modernity as the differentiation of three social spheres – the market, the state and civil society (Wallerstein, 2004:6). It is this differentiation that led to the birth of Economics, Political Science and Sociology, as separate disciplines.

The financial crisis has upended the discipline of Economics. Much criticism is expressed about the failure of Economics to predict the global financial crisis, and in hindsight, the shortcomings of contemporary economic theory (The Economist, 2009:11-12). It is outside the study’s purview to explore these debates in depth; however, I share the current criticism of contemporary economic theories relative to the financial crisis, and the proposed study will argue that part of the problem is the shortage of political economic theory – requiring moving away from the narrow focus on the modes of production and distribution only. Concomitantly, Political Science will be better served in constructing theories on the level of analysis of the political economic system, as opposed to sub-systems of power and authority only. The Economist recently argued in an editorial for a reinvention of Economics (2009:12). I would like to restate their argument as follows (inclusions in brackets are my own words and not the original article’s conslusions):

Add these criticisms together and there is a clear case for reinvention, especially in macroeconomics [and Political Science]. Just as the Depression spawned Keynesianism, and the 1970s stagflation fuelled a backlash, creative destruction is already under way. [Perhaps the 2007 Global Financial Crisis will help bridge the gap between Economics and Political Science?] Central banks are busy bolting crude analyses of financial markets onto their workhorse models. Financial economists are studying the way that incentives can skew market efficiency. And today’s dilemmas are prompting new research: which form of fiscal stimulus is most effective? How do you best loosen monetary policy when interest rates are at zero? [What are the proper roles of government and government institutions in managing systemic crisis?] And so on.

But a broader change in mindset is still needed. Economists [and Political Scientists] need to reach out from their specialised silos: macroeconomists must understand finance, [Political Scientists must understand macroeconomics], and finance professors need to think harder about the context within which markets work. And everybody [including Political Scientists] needs to work harder on understanding asset bubbles and what happens when they burst. For in the end economists [and Political Scientists] are social scientists, trying to understand the real world. And the financial crisis has changed that world.

I have defined the ontological framework of my proposed study above. It is obviously quite a broad definition of the legitimate subject matter. This is necessary given the broad formulation of the research question, but impractical given the scope of the study. Is the research question then too broad? I believe not, given my hypothesis. In terms of the Credit Expansion Mispricing of Mortgage Risk Hypothesis, the key causal variable precipitating the crisis is credit expansion. The proposed study will be mostly limited to discussing the validity of credit expansion as it relates to the mispricing of mortgage risk. It is my contention that credit expansion and the pricing mechanism of risk are to be best understood within a political economic context, since both the power-authority dimension and the production-distribution dimension of the system of resource allocation were in play in expanding credit in the global financial system.

•5. Theoretical Framework

In selecting a theoretical framework, many contending theories were considered as possible explanatory frameworks within which to fit the Credit Expansion Mispricing of Mortgage Risk Hypothesis. The proposed study will provide an overview of some of the theories considered, and the reasons for not selecting them. Elements of many theories do apply to how the crisis unfolded, but were ultimately unsatisfactory as an explanatory framework for the study’s hypothesis. Theories and theoretical approaches considered were World-Systems Theory or World-Systems Approach (Wallerstein, 2004); Braudel’s Structuralism (Braudel, 1977 and as applied by Germain, 1997); Complex Interdependence, Regime Theory and Keohane’s Institutional Theory (Keohane, 2002; Keohane & Nye, 2000; Keohane & Nye, 1977; Cohen, 2008); Hegemonic Stability Theory (Cohen, 2008; Kindleberger, 1973); Coxian Critical Theory and Historical Structures Approaches (Cohen, 2008); Friedman’s Quantity Theory of Money (Friedman, 2005); Fama’s Efficient Market Hypothesis (Fama, 1970); and Austrian School Libertarianism (Ebenstein, 2003).

I finally settled on Hyman Minsky’s (1975; 1986; 1992; Kindleberger, 2000; Cooper, 2008) Financial Instability Theory.[8] The proposed study will provide an in-depth discussion of the theory, including the empirical evidence as provided by Kindleberger’s (2000) seminal application and expansion of the theory in studying historical financial crises.

Minsky (1992) characterizes the current dominant economic system as a capitalist economy with expensive capital assets and a complex, sophisticated financial structure. The capital development of a capitalist economy is accompanied by exchanges of present money for future money. Present money finances the resources for the production of investment output. Future money is the profit that will accrue to the owners of capital assets. Investment by producers is financed through liabilities. Money is connected with financing through time, with banks and financial intermediaries as the central players. The key economic exchange is the negotiations between bankers and businesspeople.  Negotiations revolve around the cost and profit expectations of businesspeople.

Money flows from depositors to banks, and then from banks to firms and companies needing investment financing. At a later date the flow is from firms and companies, back to banks, and then to the depositors.

This flow is important to understand since it explains the linkage between the creation and ownership of capital assets on the one hand, and the structure of financial relations and changes in this structure on the other.

The Financial Instability Theory attempts to explain the impact of debt on system behavior. Bankers (the generic term Minsky uses to depict all financial intermediaries) are key players in his theory as merchants and innovators of debt.

Minsky (1992) identifies three different types of income-debt relationships, namely, hedge, speculative and Ponzi finance. Hedge Financing Units can fulfill all of their contractual payment obligations by their cash flows. Speculative Finance Units can meet their payment commitments, although their cash flow will not allow them to repay the principle, requiring them to roll over their liabilities. Lastly, Ponzi Financing Units cannot fulfill either repayment of principle or the interest due on outstanding debts from cash flows from operations, requiring them to borrow more to pay interest commitments, or sell assets to fulfill commitments. As Minsky (1992:7-8) states:

“It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.”

Kindleberger (2000) uses Minsky’s model and broadens it in his model of financial crisis. The proposed study will utilize the broadened Kindleberger model in applying the five phases of a financial crisis to the 2007 Global Financial Crisis. The five phases according to Kindleberger (2000) are:

  1. Displacement: Some change in economic circumstances creates new and profitable opportunities for certain companies.
  2. Euphoria: Investment and production picks up, and the boom is fed by an expansion of bank credit that enlarges the total money supply. There is an urge to speculate and it is translated into effective demand for goods or financial assets.
  3. Mania: The prospect of easy capital gains attracts newcomers and swindlers. There may be pure speculation for price rises, an overestimation of prospective returns, or excessive “gearing.”  Speculation for profits leads away from normal, rational behavior to a “mania” or a “bubble.”
  4. Distress: As the speculative boom continues, interest rates, velocity of circulation, and prices all continue to increase. A few insiders realize that the future expected profits cannot possibly justify the exorbitant prices, and they take their current profits by selling out. The top of the market is now being balanced with insiders withdrawing and new speculators entering. Hesitation enters the market. There is an awareness on the part of a considerable segment of the speculative community that a rush to liquidity might ensue.
  5. Revulsion: This phase is characterized by bankruptcies and liquidations. Banks discontinue lending on the collateral of certain commodities and securities. The revulsion may go so far as to lead to panic. The panic will feed on itself until one of three things occur. Prices might fall low enough to attract investments back to less liquid assets; trading could be curtailed or limited; or, a lender of last resort steps in to provide liquidity.

In the Kindleberger-Minsky financial crisis model the lender of last resort becomes a critical component in managing a financial crisis. A lender of last resort that steps in to stabilize a crisis is usually a government, or a central bank. Kindleberger (2000:207) argues that a lender of last resort seems to shorten the business depression or recession that follows a financial crisis. Government or central bank decisions to act as lenders of last resort to defuse a crisis are essentially political questions.

In applying his theoretical model Minsky is a Structuralist (Tymoigne, 2008:35). Minsky argued for a big government that establishes structural programs to directly tackle socio-economic problems. Minsky wanted a proactive form of government that takes initiatives to direct the economy toward more stable and fair forms of capitalism (Tymoigne, 2008:35).

The policy problem is to devise institutional structures and measures that attenuate the thrust of inflation, unemployment, and slower improvements in the standard of life without increasing the likelihood of a deep depression” (Minsky in Tymoigne, 2008:18).

The Financial Instability Theory sees capitalism as dynamic; therefore, no definitive solution exists for government management of the economy. Government policy needs to be fluid and flexible to respond to, and proactively anticipate, changes in the institutional structure of the capitalist economy.

It will be the argument of the proposed study that the Financial Instability Theory is a Political Economic theory, covering both dimensions of global resource allocation. The salience of the theory is well expressed by Janet Yellen, president and CEO of the Federal Reserve Bank of San Francisco:

… with the financial world in turmoil, Minsky’s work has become required reading. It is getting the recognition it richly deserves. The dramatic events of the past year and a half are a classic case of the kind of systemic breakdown that he – and relatively few others – envisioned” (Yellen, 2009).

•6. Research Design and Methodology

The proposed study will be limited to applying Minsky’s Financial Instability Theory, as well as Kindleberger’s expansion of the theory, to the 2007 Global Financial Crisis in answering the research question. A literature study will be undertaken to explain the theory, and address criticism to the theory. Since the 2007 Global Financial Crisis is a very recent phenomenon that is still unfolding, there is very limited academic literature on the topic. In describing the chronology of the crisis, the proposed study will review and include, where applicable, primary data related to the crisis, and conduct interviews with some key individuals affiliated with financial firms that experienced the unfolding of the financial crisis first hand. The proposed study will also make use of journalistic coverage of the crisis in describing the chronology. My own personal experiences managing an investment firm affiliated with one of the largest  broker-dealers in the US will be included very judiciously.

The proposed study is then a qualitative study testing the validity of a particular theory by applying it to a single phenomenon. The study will follow a deductive logic in describing the event. By applying the selected theory to explain the event, event characteristics will serve as empirical facts supporting the validity of the theory. The study will make use of a few selected historical occurrences in discussing and applying the theory to the event. However, the proposed study will not be a comparative analysis of the 2007 Global Financial Crisis and financial crises of the past.

•7. Structure of Proposed Study

The proposed study will contain the following chapters.

Chapter One: Introduction

The first chapter will introduce the theme, the research problem, the research question, and the theoretical framework of the study. The importance of the study will be discussed, as well as the limitations and delimitations.

Chapter Two: Financial Instability Theory – The Theoretical Discussion

The second chapter will provide a thorough analysis of Minsky’s Financial Instability Theory, and Kindleberger’s expansion of the theory. The theory’s validity will be discussed, including criticism of the theory. This chapter will also define Political Economy, and the justification for analyzing the 2007 Global Financial Crisis as a political economic event.

Chapter Three: The 2007 Global Financial Crisis – The Historical Discussion

Chapter Three will provide a chronological discussion of the unfolding of the financial crisis. The crisis will be described from the perspective of political economy. Issues of subjectivity in describing the crisis will be discussed in this chapter.

Chapter Four: The Application of the Financial Instability Theory – The Contextual Discussion

Chapter Four will analyze the 2007 Global Financial Crisis by using the Minsky-Kindleberger Financial Instability Theory. The validity of the theory as an explanatory framework for the crisis will be discussed. Based on the application of the Financial Instability Theory, this chapter will aim to identify the causal factors resulting in the crisis. This chapter will also discuss the event-specific hypothesis of the study, how it fits within the theory, and the hypothesis’ validity in explaining the 2007 Global Financial Crisis.

Chapter 5: The Management of Global Financial Instability – The Predictive Discussion

In the fifth chapter I will offer tentative observations about the utility of the Financial Instability Theory in “managing” global financial crises. The important issue of a lender of last resort will be discussed, as well as tentative observations regarding the prevention or mitigation of future financial crises, and the implications for government policy.

Chapter 6: Conclusion

The final chapter will summarize the findings of the study, and conclude with the validity of the Financial Instability Theory as an explanatory model of financial crises. This chapter will also conclude on the validity of the Credit Expansion Mispricing of Mortgage Risk Hypothesis to explain the 2007 Global Financial Crisis.

•8. Time Schedule

The thesis will be submitted by December 2010. I will aim to complete the chapters by the following dates:

Chapter One by the end of September 2009.

Chapter Two by the end of November 2009.

Chapter Three by the end of February 2010.

Chapter Four by the end of May 2010.

Chapter Five by the end of August 2010.

Chapter Six by the end of October 2010.

During November and December of 2010 the thesis will be finalized for submission.

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Yellen, J.L. 2009. “A Minsky Meltdown: Lessons for Central Bankers.” Presentation to

the 18th Annual Hyman P. Minsky Conference on the State of the US and World Economies – “Meeting the Challenges of the Financial Crisis.” New York. Levy Economics Institute of Bard College.

[1] The Research Proposal will be written in American English.

[2] The Overnight Index Swap (OIS) is a derivative used by hedgers to manage their fixed or floating assets and liabilities.

[3] The federal funds rate is the rate that depository institutions charge each other for overnight loans using federal funds at the Federal Reserve of the United States of America. The federal funds target rate is arguably the most important rate, and is set by the Federal Open Market Committee of the US Federal Reserve System. Federal funds refer to the reserves depository institutions hold at the different Federal Reserve Banks in the US to meet their reserve requirements.

[4] The proposed study will define “system” as a group of interrelated, interacting and interdependent components forming a complex whole. I argue that the social components responsible for how resources are allocated within societies form a complex whole – what I call the system of resource allocation. The proposed study will deal with these definitions in depth. My conception of “resources” includes Easton’s (1981) idea of “values.”

[5] I do not propose that nation states alone hold a monopoly over power, of course there are other institutions with significant power and authority, like multinational corporations, multinational governmental institutions, like the European Union, drug cartels etc.

[6] I use the plural for market, since it is a misnomer to refer to “the market” as encompassing the many different markets for different goods and services.

[7] One could even make the case that the proper name for the discipline should be “Political Economics,” with Political Science and Economic Science the sub-disciplines.

[8] Minsky referred to his thesis as the “Financial Instability Hypothesis.” It is my contention that there is ample empirical evidence to upgrade the “Financial Instability Hypothesis” to the status of “theory.” For instance Kindleberger’s application of Minsky’s model to many historical financial crises, and his expansion of the model (Kindleberger, 2000).

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