Minsky Moment

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Minsky Moment Meaning

Minsky Moment refers to an abrupt market collapse or bubble burst following a temporary long bullish trend. The term representing the starting of a downfall in the economy conveys that an unstable scenario will follow a stable system.

Minsky Moment Meaning

The phrase derived from the American Economist Hyman Philip Minsky's academic works is first used by the American Economist Paul Allen McCulley to interpret Russia's financial crisis in 1998. Furthermore, the concept is predominantly seen in explaining past financial crises and probable upcoming troubles. The severity or intensity of the crisis following the collapse positively correlates with the length of recent bullish speculation.

Table of contents
  • Minsky Moment definition portrays it as the event representing a market collapse or bubble burst marking the end of a long bullish period and indicating the start of a long recession phase.
  • In 1998, Paul McCulley coined the term after an American economist Hyman Minsky to interpret Russia’s financial crisis.
  • Based on Minsky’s Financial Instability Hypothesis, the three phases of credit lending are hedge, speculative borrowing, and Ponzi.
  • One of the famous examples is the burst of the housing bubble in 2008, followed by the Great Recession in the United States.

Minsky Moment Explained

Minsky Moment implies specific events or occurrences indicating the start of a recession in the economy. The basic concept behind this is obtainable from a famous Hyman Minsky quotes: "stability breeds instability" and "stability is destabilizing." If an economy is stable, it is likely to become unstable in the immediate period or future.

According to the theory, when the market is in a booming phase, the market participants become increasing optimistic and thus indulge in higher risk. They are ready to take more loans, indulge in speculative activities and thus, both borrowers and lenders go beyond their capacity, making the financial system fragile.

Thereafter comes the moment when the participants realise their inability to handle the debt they have accumulated, leading to loss of confidence. This realization triggers a very fast contraction in the borrowing and lending process. This leads to fall in asset prices, debt default and bankruptcy. There is a downward spiral of economic downturn and financial crisis.

A stable economy gives confidence to its people, making them less risk-averse, and they end up making high-risk decisions. In a nutshell, it starts with a scenario where cautious investors make safe decisions then, followed by a rising economy giving fair returns to market players. The rising economy, easy credit policies, government interventions, and monetary policies boosting the rise ascertain investors' optimism, leading to irrational decisions in contrast to fundamental analysis. All these events build unsustainable bullish speculation. However, when a sudden crash occurs, everything reverses.

Another point projected by Minsky is the irrelevance of the "equilibrium model" or the assumption of a fundamentally stable economy. He believed that the economic crisis is not a sole result of external shocks, but the system is capacitated to create shocks. For example, the easy credit availability factor is one of the reasons that led to the housing bubble and its burst in 2008.

Phases Leading To Minsky Moment

Hyman Minsky's Financial Instability Hypothesis postulated three phases leading to a Minsky Moment. These three credit lending stages have their risk levels growing with each step and finally ending with a market collapse or bubble burst.

Minsky Moment - Phases

#1 - Hedge Phase

It is the first phase explained in the Minsky theory. Stringent credit policies and high lending standards decor the market, and along with the memories of recent collapse, people exhibit risk-averse behavior. Hence, there is a safe level of total debt in the economy. Borrowers can meet the principal and interest expenses utilizing the cash flow from investments.

#2 - Speculative Borrowing Phase

The speculative borrowing phase follows the hedge phase. Then, businesses, profit, and economy start rising, credit guidelines are loosened, and the level of debt increases. Borrowers meet their interest expenses during this phase, but the principal repayment from the investment income will be stressful.

#3 - Ponzi Phase

The Ponzi phase is the phase before the bubble burst or market collapse. This phase exhibits optimistic people controlled by irrational exuberance taking risky decisions. The phase witnesses a high level of debt, high-risk activities, high valuation of assets, and increased selling of assets. Moreover, borrowers find it difficult to meet the principal and interest expenses. Finally, all these events led to a crash and subsequent recession.

Examples

Let us try to understand the concept with the help of some suitable examples as give below.

Example #1

One famous Minsky Moment example is the housing bubble burst of 2008 in the United States. When the people are presented with easy credit availability exemplifying the subprime lending events, it accumulates household debt and increases asset prices. This unsustainable bullish speculation thrived for a prolonged period and contributed to the upward expansion of the US economy for a significant period. However, the housing prices started traversing the downward slope during mid-2006 to 2007, leading to the collapse of the housing bubble in 2008, followed by the Great Recession in the United States.

Example #2

In recent years, the potential of a sudden collapse can be attributable to the Covid 19 pandemic scenarios. For instance, the chance of a Minsky Moment 2021 or 2022 was very high when markets have been broadly positive, with traders betting on further stimulus from governments and central banks, as well as the administration of a coronavirus vaccine. Despite persisting worldwide economic threats from the Covid-19 outbreak and geopolitical uncertainties, the stock market is exhibiting indications of strength, with indices and FAANGs riding high.

The above examples clearly explain the concept which states the instability of the economy to control the financial system and the situations when the economy is into a borrowing spree without having the capacity to repay the debts. The concept highlights that it is important to monitor the risk and debt levels to avoid and disruptive consequences.

Frequently Asked Questions (FAQs)

What is the Minsky theory?

Hyman Minsky's economic theories were mostly ignored until the subprime mortgage crisis of 2008 sparked new interest in them. Then, Hyman Minsky's debt racking up ideas garnered public attention.   The concept is famously known as "the Minsky Moment." According to Minsky, the prime factor leading to the economic crisis is the debt accumulation by activities of the non-government sector. He categorized borrowers into hedge borrowers, speculative borrowers, and Ponzi borrowers.

What are the three stages of Minsky's instability hypothesis?

Minsky's instability hypothesis's three stages or phases are the hedge phase, speculative borrowing phase, and ponzi phase. Firstly, the hedge phase manifests an environment with stringent credit policies and low-risk activities. Next, the speculative borrowing phase will have loose credit policies with increasing debt and a rising economy. Finally, the Ponzi phase exhibits high debt and risky activities, leading to the Minsky Moment.

What did Minsky mean by stability breeds instability?

"Stability breeds instability" is one of the Hyman Minsky quotes. It indicates the belief that when people become optimistic about the present or economic outlook, they prefer to spend, incur loans, invest, and so on. This less risk-averse behavior can lead to imbalances contributing to economic destabilization or collapse.