Minsky Moment Meaning Hyman Quotes Example Phases

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 crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more 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.

Key Takeaways

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 economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. 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.

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 policiesMonetary PoliciesMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more boosting the rise ascertain investors’ optimism, leading to irrational decisions in contrast to fundamental analysisFundamental AnalysisFundamental Analysis (FA) refers to the process of studying any security’s intrinsic value with the object of making profits while trading in it. The primary purpose of fundamental analysis is to determine whether the security or stock is undervalued or overvalued and thereby make an informed decision to buy, hold, or sell it in order to maximize the potential for gains.read more. 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 bubbleHousing BubbleA housing bubble is a duration in which the cost of houses and other real estate properties increases dramatically at the local or global level. The prices can continue to grow at any time until the supply eventually catches up. The trend can end with a sudden drop in house prices, causing the bubble to burst.read more 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.

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#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 debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more in the economy. Borrowers can meet the principal and interest expenses utilizing the cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more from investments.

#2 – Speculative Borrowing Phase

The speculative borrowing phase follows the hedgeHedgeHedge refers to an investment strategy that protects traders against potential losses due to unforeseen price fluctuations in an assetread more phase. Then, businesses, profit, and economy start rising, credit guidelines are loosened, and the level of debt increases. Borrowers meet their interest expensesInterest ExpensesThe formula for calculating interest expense is divided into two types: the first is the simple interest method, which involves multiplying the principal outstanding, the rate of interest, and the total number of years (ptr). The second approach is the compound interest method, which involves multiplying the principal by one plus the annual rate of interest raised to the number of compound periods less one, and then deducting the resultant value from the total initial sum .read more during this phase, but the principal repayment from the investment incomeInvestment IncomeInvestment income is the earnings made from allocating funds in financial instruments or assets like securities, mutual funds, bonds, property, etc. It includes dividends on bonds and interest received on bank deposits, profits and capital gain from the sale of real estate and securities. read more 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 exuberanceIrrational ExuberanceIrrational exuberance refers to the enthusiasm or optimism exhibited by the investors without going for rational thinking, causing an exponential rise in asset prices. read more 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.

Example

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.