Re: Prospects vs Forecasts/Was Minsky non-ergodic?

[Paul Davidson <pdavidson@xxxxxxx>]

At 01:28 PM 8/24/2002 -0400, you wrote:

Paul

[Clifford Poirot]

It is because of uncertainty about future cash flows that current hedge units can become Ponzi units (as Minsky himself noted). As Minsky noted, the ability to project these cash flows is dependent on the maintence of aggregate demand (and I would add of other factors as well such as consumer preferences, technological change, etc.) which are unpredictable.

 

To argue that a current hedge position can become a Ponzi position does not mean you cannot make intelligent decisions today about whether a proposal is a hedge, speculative or Ponzi proposal. That we cannot form reliable probability distributions into the future is why loan officers must resort to rules of thumb.

 

Here is a simple example. A loan officer faces three prospects for a small business loan:

Prospect  1: An applicant requests a loan to buy a business, that is fully backed by the existing assets of the business. The income generated by the business for the last five years will cover the principal and interest payments. The applicant is also willing to pledge his home equity. This is clearly hedge finance. Anyone can tell, that this business is not guaranteed success, but it generates a current cash flow sufficient to meet all obligations.

 

Prospect 2: An applicant requests a loan to start a new business. In order to meet the principal and interest payments, the business will have to generate a steady increase in sales volumes beyond first year projections. It will require balloon financing. this is speculative financing.

 

Prosect 3: Prospect 3: the applicant requests a loan for a business in order to pay off existing debt that the business is unable to pay out of current sales. In order to meet future interest and liability payments, the business will have to sell existing assets.

        

In the
good old days the loan officer looked for the three C's-- Collateral,
Credit history and Character--
Even that did not insure that the loan would not become non
performing--but if the collateral was sufficient then that could be
liquidated to pay off the loan contract.  Even then there was always
some loans that ended in default and loss.

 

Of course, 1 can become 3. But at the present time, they are in different situations and they can be evaluated differently. Now, let's suppose the loan officer decides that he can securitize and sell all three loans and thus makes all three,

Securitization merely passes off the possibility of default to others --
loan officers then do not care about the three C's as they unload the
loan contract almost immediately -- make their money on origination fees
and debt service fees.. Loan officvers then become loan pushers -- and
the likelhood of default becomes greater.

Paul Davidson

Editor, Journal of Post Keynesian Economics

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