This paper gives a detailed exposition of Hyman Minsky’s Financial Instability Hypothesis which takes the US financial system as its reference structure and provides a historical account of financial sector evolution and regulatory changes in the US in the run up to the current crisis. In Minsky’s approach, fragility is inherent in the successful operation of the capitalist economic system, and results from changes in the liquidity preferences of bankers and businessmen for a given degree of maturity mismatching. While financial fragility is independent of financial regulation, regulation may play a role in the rate of propagation of fragility, or in preventing the transformation of fragility into major instability such as the one that occurred during the Great Depression. Given that the current crisis appears to be similar to that which led to the breakdown of the financial system through debt deflation in the 1930s, a similar remedy in the form of a Reconstruction Finance Corporation and re-regulation of the financial system are called for.

June 15, 2009.