Mike: When the mortgage bubble burst, it had some very negative consequences on the economy. Beneath the mortgage crisis, which could have been avoided of course, there is a pervasive underlying crisis inherent to our system.

Rick: What do you mean by a pervasive underlying crisis?

Mike: Years ago, a brilliant economist by the name of Hyman Minsky noticed that crises in Capitalist economies were probably due to the relationship between two factors: the expansion of the financial sector and the evolution of the real sectors of the economy.

Rick: How are the two related?

Mike: Well, Minsky’s theory explained that when a capitalist economy is growing, investors have a tendency to overestimate and overreact to good news. This situation leads them to develop an overconfident view of the future. They get into excessive debt so they can have more money to invest. They end up investing beyond the real needs of the economy.

Rick: Do you mean that investors become excessively positive and think the good times are going to last forever, and over-invest in the economy?

Mike: That’s right. Investors get deeper and deeper into debt. The economy becomes unstable because of the excessive debts and investments.

Rick: I understand now. That’s how investors can make money by getting out of touch with the real needs of the economy. Some investors can purposely invest more into the market so that others see the market rising. They invest their own money into it, thinking there is still enough demand from the market triggered by real economic needs. Then the first investors sell their stocks at prices that are suddenly very high. They let the market flop, hurting a lot of honest investors.