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Credit has grown rapidly in recent years. This expansion has come in many forms, from home mortgages to newfangled structured products created by clever financial engineers. There are, broadly speaking, two views about these developments. The conventional wisdom -- held by most economists and denizens of Wall Street -- is optimistic. Higher rates of credit growth and increasing levels of leverage, they maintain, are reasonable in light of increasing economic stability.

An opposing view -- held by a miscellaneous bunch, including some notable investors and Wall Street observers -- holds that the massive buildup of debt augurs ill. Drawing on the work of a little-known, deceased economist named Hyman Minsky, the pessimists contend that the recent calm has induced people to take on too much risk. "Stability is unstable," this group says, quoting Minsky. Like the differences of opinion toward the end of the last decade concerning the existence or not of a stock market bubble, the current argument will be settled only by the unfolding of events. Either the prosperity will continue in the years to come, or a financial crisis will occur.

But not everyone can afford to await the passage of time. Professional investors are paid to anticipate. Adherents to the conventional view will construct radically different portfolios from those who accept the instability hypothesis. Many investors, however, are undecided. They believe, or perhaps just hope, that prosperity will endure while at the same time they may feel uneasy about the growth of credit and other risk-taking behavior evident in today's markets. The purpose of this essay is to introduce Minsky's unorthodox ideas and relate them to recent developments in the financial world. Readers should then be better able to judge for themselves where they stand.

THE GREAT MODERATION

Just over a decade ago, a Wall Street equity strategist published a report that helped give birth to the so-called New Paradigm of the 1990s. The monetary authorities, asserted David Shulman of Salomon Brothers, had improved their handling of the economy. Recessions had become less severe and frequent, and inflation was under control. Shulman argued that as a result of these developments, equities should trade at higher multiples than in the past -- the "valuation paradigm" had changed.

The New Paradigm was later used to rationalize the lofty equity valuations at the turn of the century and was much mocked when the bubble eventually burst. But it didn't entirely go away. Rather, the New Paradigm was given a name change. According to central bankers, we currently live in the age of the "Great Moderation" -- a term coined by Ben Bernanke, now Federal Reserve Board chairman, back in 2004. His argument was very familiar, although expressed, in the argot of modern finance, in terms of risk and volatility: The world had become more stable and predictable, economic growth was steadier, and inflation didn't oscillate so violently.