Minsky moment

Description

According to the hypothesis, the rapid instability occurs because long periods of steady prosperity and investment gains encourage a diminished perception of overall market risk, which promotes the leveraged risk of investing borrowed money instead of cash. The debt-leveraged financing of speculative investments exposes investors to a potential cash flow crisis, which may begin with a short period of modestly declining asset prices. In the event of a decline, the cash generated by assets is no longer sufficient to pay off the debt used to acquire the assets. Losses on such speculative assets prompt lenders to call in their loans. This rapidly amplifies a small decline into a collapse of asset values, related to the degree of leverage in the market. Leveraged investors are also forced to sell less-speculative positions to cover their loans. In severe situations, no buyers bid at prices recently quoted, fearing further declines. This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash.

The more general concept of a "Minsky cycle" consists of a repetitive chain of Minsky moments: a period of stability encourages risk taking, which leads to a period of instability when risks are realized as losses, which quickly exhausts participants into risk-averse trading (de-leveraging), restoring stability and setting up the next cycle. In this more general view, the Minsky cycle may apply to a wide range of human activities, beyond investment economics.

Context

The term was coined by Paul McCulley of PIMCO in 1998, to describe the 1998 Russian financial crisis, and was named after economist Hyman Minsky, who noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Minsky opposed the deregulation that characterized the 1980s.

Some, such as McCulley, have dated the start of the 2008 financial crisis to a Minsky moment, and called the following crisis a "reverse Minsky journey"; McCulley dates the moment to August 2007, while others date the start to some months earlier or later, such as the June 2007 failure of two Bear Stearns funds.

Notes

References

1. . (22 August 2007). ["In praise of ... Hyman Minsky"](https://www.theguardian.com/commentisfree/2007/aug/22/comment.business). *The Guardian*.
2. Minsky, Hyman. (1975). "John Maynard Keynes". McGraw-Hill Education.
3. Lahart, Justin. (2007-08-18). "In Time of Tumult, Obscure Economist Gains Currency—Mr. Minsky Long Argued Markets Were Crisis Prone; His 'Moment' Has Arrived". The Wall Street Journal.
4. Cassidy, John. (28 January 2008). "The Minsky Moment".
5. McCulley, Paul. (April 2009). "Playing solitaire with a deck of 51, with number 52 on offer: Comments before the Money Marketeers Club". [[Pimco]].